Executive Summary Where are we, six months into the coronavirus recession? The authors look back at five common expectations from the early days of the crisis and how they differ from where we are today. The differences in macroeconomic outcomes can largely be explained by countries’ health care and economic policies. Perhaps surprisingly, the authors found that aggressive economic policy can offset shortcomings in health care policy. Jasmin Kämmerer/EyeEm/Getty Images Six months after the start of the coronavirus recession the macroeconomic landscape has become more, not less, confusing. Business leaders have to navigate shattered expectations, widely disparate outcomes, and continued uncertainty. Although we have seen the worst growth decline on record, financial markets are buoyant. It’s time to take a step back and reflect on the journey so far. What Was Expected — and What Happened As the crisis unfolded in February and March of this year, business leaders were forced to rapidly shift their expectations for the future. While expectations varied, we identified five disparities between common assumptions at the time and our current realities. 1. Intensity was underestimated. Economic forecasts gyrated wildly at the start of the crisis. For example, the median broker forecast for 2Q U.S. growth was still around 0% in mid-March, before collapsing 30 percentage points over the next 20 days. Over the following months the forecast settled around -35% (annualized – not to be confused with, but equivalent to, -10% quarter on quarter growth). That figure turned out to be closer to the truth (actual growth was -33% annualized, or -9.5% q/q) but the spread around the median forecast remained extremely large. Regardless of future revisions, a historically bad growth decline is now a fact and the episode highlights the limits of modeling outside of the known empirical range. 2. Systemic stability risks were overstated. The severe intensity of the crisis fueled fears of systemic meltdown, driven by liquidity and solvency problems cascading through the real and financial economy. Those risks stoked concerns of a “new great depression,” while the unprecedented policy response also stoked concerns over higher inflation, often portrayed as the trigger for a U.S. debt crisis and the end of dollar hegemony. Though fears remain, they have not been realized so far, as monetary policy has contained stress in the financial system and unprecedented fiscal policy has shored up real economy balance sheets. 3. A false dichotomy was predicted between emerging and developed economies. A common expectation was that affluent economies would weather the crisis more adroitly than less developed ones, whose ability to respond with policy would be more limited. Yet expectations about a clean correlation between economic heft and crisis outcomes, including health outcomes, have not been realized. The wide distribution of outcomes within the “developed” and “emerging” economy clusters (think U.S. vs. Greece, or Brazil vs. China) illustrates the false dichotomy. 4. Recovery “shapes” were more widely dispersed. Expectations for the path of the recovery were hotly debated, though a dominant early expectation was for a V-shaped — i.e. return to pre-crisis trends — recovery. While this today seems hopeful, ultimate recovery shapes are still being written. In fact, V-shapes have emerged at both national level (notably China) and also within the U.S., where, for example, retail sales and housing (new home sales) have bounced back and exceeded pre-crisis levels. As recovery “shapes” are more about the eventual return to pre-crisis levels and growth rates, and less about speed, it is too early to tell. Perhaps what can be said with some confidence today, is that a full return to pre-crisis trend paths looks ever more challenging as time passes and capital stock growth slows in the crisis. 5. Long-term legacies may be more concentrated than thought. The extreme intensity of the crisis infected expectations that everything will be different post-Covid. It is too early to say, but first contours have emerged on three dimensions of legacy: a break in the economic structural regime remains unlikely, particularly for the U.S. economy; as mentioned above, the structural damage question remains in flux; however there are many facets of microeconomic and behavioral shifts that look likely to become permanent, creating opportunity in adversity for some sectors and companies. Economic Policy Can Substitute for Public Health Failures While all economic downturns have their own idiosyncrasies, the underlying dynamics of this pandemic-induced recession were similar across the world: A health emergency requiring restrictive public health interventions creates a severe economic disruption, which must be bridged by economic policy. We have observed a degree of substitutability between the two policy dimensions that shape macro outcomes: Successful public health interventions reduce the cost, risk, and complexity of the needed economic policy response. However, where virus control is lacking, aggressive economic policy can offset shortcomings in health care policy. The U.S. is a case in point. Hopes that rich nations would easily control the virus were quickly dashed as it became clear that a specific mix of institutional capabilities — including health policy, government coordination, communication, and support in civil society — mattered more than economic heft. However, despite this public health outcome, the U.S. has fared somewhat better economically in 2Q than Europe where public health outcomes are widely seen to be better. The key driver of this outcome is the speed, depth, and breadth of the U.S. economic policy response that dwarfed European efforts. Economic policy capacity has effectively offset shortcomings on the health side. While minimizing the health crisis is an important goal in its own right, we think it’s difficult to link the public health outcomes with expected economic outcomes without considering the idiosyncratic abilities and willingness of nations to bridge the disruption with economic policy. The Road and Risks Ahead What can the disparities of the coronavirus crisis so far tell us about the future? Equity markets are one means to gauge the future, as the asset class purports to reflect the present value of future cash flows. The full recovery to pre-crisis levels of some U.S. markets is widely seen as seriously dissonant with the extreme hardship afflicting the real economy. Yet, apart from some idiosyncrasies (large weight in tech stocks who have won in the pandemic as well as increasingly negative real rates making equities relatively more attractive), we think the markets reflect an embedded view on the substitutability of health policy and economic policy. At this point, expectations for much more than a “muddling through” in the U.S. health policy are optimistic, however expectations for unparalleled economic policy efforts are more plausible. This will help — albeit at likely escalating cost and risk — to bridge the economic gaps left by the health care response. Equity markets have taken a view that U.S. economic policy willingness (culture of stimulus) and capacity (reserve currency status, debt capacity, and an anchored inflation regime lend the U.S. unrivaled capacity) more than offset weakness in health policy. U.S. markets’ strong performance, particularly the strong absolute recovery but also the relative outperformance (Europe), are partly driven by this view. However, this view of the future harbors two significant risks. The first stems from the market’s large bet that the aggressive hunt for a vaccine will shorten traditional development timelines. Any whiff of failure or significant delay would pierce a hole in this view, raising questions about the degree that economic policy can hold economic activity together. The second risk — potentially more damaging — is that economic policy could fail to continue bridging the gap in economic activity. As we wrote here before, this failure can generally emerge from either inability (markets reject debt issuance) or unwillingness (political failure to act). While inability is very unlikely for the U.S., unwillingness is not. At the start of an overwhelming crisis political polarization was kept in check at first. But as the crisis drags on and an election season beckons, bipartisanship can turn to intransigence. The economic response to Covid-19 could still turn into a political football. What Leaders Can Do Now Six months into this crisis, economic outcomes are no more certain — arguably less so. Here are a few things business leaders can do to prepare for the next phase of the coronavirus crisis: Pause and take stock. As curves have been flattened and economies reopened, albeit with varying degrees of success, now is the right time to take stock not only at the macro level, but also more specifically — within sectors, industries, and segments — and to reallocate resources appropriately. Build resilience. Actively prepare for multiple futures by creating optionality to maneuver. It’s tempting to see a path ahead and bet on it, but if anything, coronavirus has demonstrated the immense power to surprise and upend even well thought out assumptions about how the world works and who is likely to win. Capture advantage. Leaders also should remember firm strategy is about beating trends and averages. The greater the dispersion in outcomes across countries and sectors, the greater the opportunities for individual outperformance for those who can see them and mobilize around them.