Global equity markets were modestly lower over the past week. The investing backdrop hasn’t changed much over the past month. The global economy has been resilient and investors expect growth to strengthen as the year progresses despite renewed concerns on the virus front. The heightened volatility in bond markets has subsided to some degree as central bankers have tried to reassure investors that policy will remain very supportive. Nevertheless, inflation concerns linger in the background and are the primary reason equity markets have struggled to push higher. This week, we provide an update on the virus front and explain why the significant increase in debt that governments are using to fund their large aid programs is not necessarily concerning.
Canada experienced a meaningful increase in new cases over the past week. The 7-day average rate of new daily infections rose to 4,500, versus the 3,300 from the week ago period. The third wave of the virus now appears to be spreading across much of the country with most provinces reporting higher rates of infection. The highest growth was in Alberta and Saskatchewan, while Ontario and British Columbia also saw relatively sharp increases. Even Quebec experienced a move higher for the first time since the beginning of the year. The East Coast experienced an uptick, driven primarily by New Brunswick, while Manitoba and the northern territories were the only regions to see limited change.
Elsewhere, countries across major continents – the Philippines, Pakistan, Poland, and Peru for example – are grappling with high and rising cases. The notable exceptions are the United States, the United Kingdom, and Israel, all of whom are further along with their vaccination campaigns.
Elevated Debt… Not a Concern For Now
Over the past year, nearly every government around the world has stepped in with financial support for individuals and businesses that have been impacted by the pandemic. That kind of response is unsurprising, particularly given the exogenous nature of the crisis. But the amount of spending undertaken has been relatively incomparable through history. Moreover, governments may not yet be done.
The U.S. government for example, recently approved an aid plan that amounted to nearly $2 trillion, which adds to a sizeable amount of stimulus approved last year. And there are growing expectations of an infrastructure oriented package that could amount to as much as $3 trillion.
Governments everywhere are largely funding these massive expenditures via new debt. According to the International Monetary Fund, the amount of global government debt jumped significantly last year. More specifically, government debt as a percentage of global economic output, rose to 98%, from a relatively high level of 84% the year before.
Typically, being heavily indebted is an unenviable position. For the average person for example, an increasing debt burden presents a financial risk as people have a finite number of working years available to pay off their liabilities. But, governments don’t ever retire. Rather, they have an unlimited period with which they can try to reduce their debt load. The simplest way is through economic growth that could lower a country’s debt-to-GDP ratio. Another approach would be to generate inflation, which effectively reduces the principal amount of outstanding loans. Two additional measures include an increase in taxes and a decrease in spending, both of which can be difficult to implement given political forces. Nevertheless, there are plausible scenarios in which governments can see their debt levels fall over time. With a growth outlook that is set to expand over the next few years, the debt levels may modestly improve over the near term horizon. But, it will take considerable time and a sustainable economic trajectory to see more meaningful progress.
In the meantime, the low interest rate environment has made the debt burdens relatively affordable for most governments. Perhaps surprisingly, the total servicing costs for some countries is set to decline over the next few years despite meaningfully higher debt; a function of countries being able to refinance maturing loans at much lower interest rates. In our view, the biggest risk is not necessarily default, but rather the reduced capacity for heavily indebted countries to act in the future when another recession or crisis inevitably emerges.
Market Decline and Recovery Results
The peak-to-trough numbers for the current market decline and subsequent recovery are provided in the table below, as of yesterday’s (Thursday, March 25th) closing prices.