The global economy looks to be recovering from the COVID-19 outbreak faster than once seemed likely. However, a big divergence in prospects is emerging between richer and poorer nations.
According to the IMF, the US economy is expected to exceed its pre-COVID level this year. The majority of advanced economies are not expected to pass this milestone until 2022, but for many developing economies (with the notable exception of China) this is unlikely to happen until well into 2023.
Much of the difference can be explained by the pace at which vaccines are being rolled out. While vaccines are being dispensed at an accelerating rate across the developed world, allowing more economies to reopen, most developing nations are a long way behind. India and Brazil in particular are struggling to contain the disease.
Vaccines the key
There are concerns that the rapid spread of the disease in India and other parts of the world could pose a threat to richer nations – even those well on the way to fully vaccinating their adult populations – as new strains emerge that can evade vaccines. However, the evidence suggests this is not a major threat. It is likely that current vaccines will remain effective at tackling new strains for several years. Over time, updated vaccines are also likely to be created that will contain the virus.
The majority of poorer nations appear to be several years from having most of their adult population fully immunised
This should mean that richer countries, where much of the population will have been vaccinated, will avoid the need for further prolonged lockdowns. By contrast, the majority of poorer nations appear to be several years from having most of their adult population fully immunised. Moreover, developing economies are more reliant than richer nations on vaccines that may be less effective at combating some strains of the virus.1 Even a rapid acceleration in the rollout of vaccination programmes will not prevent the need for some countries to employ lockdowns to control case numbers.
That said, when one considers the number of cases being reported, and the fact they are likely to be heavily underestimated, India will be building up an immunity that will make it harder for the virus to spread. Studies suggest previous infection offers a high degree of protection for several months.
Furthermore, the successful development of several effective vaccines means the world has the tools to get on top of this disease by tweaking vaccines as and when needed, massively increasing production, and ensuring supplies are distributed fairly. Much will depend on whether richer nations choose to bankroll the vaccine effort in poorer countries. Unless they do, developing nations seem likely to endure an ongoing risk of further waves of the virus for many years.
The impact on investors
In a period of sharp economic growth, one would usually expect emerging-market equities to outperform their developed-market counterparts. Not this time. The risk of a future wave of infections will weigh on investor confidence for far longer than in developed markets. Moreover, the authorities in these countries are less able to boost their economies than their colleagues in the richer world.
The outlook for developed equity markets looks brighter
The outlook for developed equity markets looks brighter, given the anticipated rapid economic growth. Although the most positive environment for equities seems behind us, rising profits should still outweigh the impact of higher interest rates, when inflation is taken into account.
As for bonds (IOUs issued by governments, companies and other organisations) in richer countries, we expect prices to fall further. That is because rapid economic growth in these countries could trigger a rise in inflation. This, in turn, could cause central banks to hike interest rates to try to cool the economy (and inflation), which would undermine the appeal of the fixed income provided by bonds.
The prices of bonds issued by governments in emerging markets could come under particular pressure if the scale of government borrowing and overall debt rises to levels that alarm investors.
Three points to remember
- The economies of richer nations are recovering much faster from the impact of COVID-19 than poorer ones, and the trend looks set to continue.
- This divergence reflects the much slower pace of the vaccine rollout in developing economies and their reliance on vaccines that are not as effective in combating the disease.
- Consequently, the outlook for equities and bonds in advanced economies is also brighter than in the developing world.