Recently, investors are growing concerned about the state of the global economy and how it affects their investments.
This article highlights what is a hard and soft landing for the global economy and what it means for investors.
1. What is a hard and soft landing?
In view of market expectations of a slowing global economy, economists are evaluating whether the slowdown will result in a hard landing or a soft landing. These terms are normally used to describe the severity of an economy’s deceleration from its current pace of growth.
A soft landing occurs when an economy sustains a mild slowdown whereby consumer and investment spending softens, but continues to register positive or flat growth. In comparison, a hard landing describes a recession with a sharp contraction in spending, resulting in many workers losing their jobs and companies significantly reducing their capital investments.
A soft landing can be illustrated by a plane landing smoothly on the tarmac - there may be some minor bumps, but overall, it is a safe landing. In contrast, a hard landing occurs when the plane has to make an emergency landing which results in damage to the plane and/or injury to the passengers.
2. Past hard and soft landings for the U.S. economy
In the 2000s, the United States’ (U.S.) economy experienced both a soft landing (in 2001 post the dotcom boom and September 11 terrorist attacks) and a hard landing (during the 2008-2009 Global Financial Crisis, or GFC). As the U.S. economy’s growth moderated from 4.1% in 2000 following the dotcom boom to 1.0% in 2001 with most consumers and companies continuing to spend and invest, this economic slowdown was considered a ‘soft landing’.
However, during the GFC in 2008-2009, the U.S.’ economic growth decelerated sharply from 2.0% in 2007 to 0.1% in 2008, and subsequently contracted by 2.6% in 2009 as the financial crisis in the U.S. and Europe significantly affected U.S. consumers and businesses; thereby resulting in a ‘hard landing’.
3. How have stock markets performed in past hard and soft landings?
Since economic conditions are one of the key factors affecting corporate earnings, the pace of an economy’s slowdown will have an impact on the momentum of corporate earnings, which may in turn influence the share prices of the listed companies. Figure 2 shows the impact of notable instances of decelerating economic growth on the U.S. equity market.
In general, a soft landing should have a moderate impact on investors’ investment portfolios. In contrast, a hard landing may lead to more volatile market conditions and have a larger impact on investors’ portfolios in the near term.
Meanwhile, despite the Covid-19 pandemic-induced recession in 2020, the S&P 500 Index registered an annual gain of 16.3% in 2020 as extensive fiscal and monetary stimulus measures were implemented to spur the U.S. economy’s recovery.
4. What factors could lead to a hard landing for the global economy?
There are 3 key risks that could lead to a hard landing for the global economy:
(i) Elevated inflationary pressures
If the geopolitical conflict between Russia and Ukraine escalates further and prolongs, this could continue to disrupt the supply of essential commodities such as natural gas, crude oil, wheat and soybean; leading to increased inflationary pressures for many countries. Additionally, while China’s recent removal of pandemic restrictions is spurring hopes for its economic revival, the ensuing increase in the country’s demand for energy and raw materials may also lead to higher inflation.
(ii) High interest rates
Secondly, to contain elevated inflation rates, global central banks (e.g. the U.S. Federal Reserve, or Fed) have tightened monetary policies via steep interest rate hikes; thereby making loans more expensive for consumers and companies. The higher level of interest rates could potentially dampen economic activities at a magnitude that is larger than expected.
(iii) Risks to China’s economy
While China has recently abandoned its zero-Covid policy, a rise in infections may still prompt the government to re-impose lockdown restrictions in selected Chinese cities. Additionally, the imposition of trade restrictions amid continued U.S.-China trade tensions could also impact manufacturing activities in China. As a global manufacturing hub and an increasingly important consumer market, a significant slowdown in the Chinese economy would pose downside risks to global growth.
5. What can central banks and governments do in a hard landing?
In the event of a hard landing, central banks and governments typically pursue loose monetary policies (e.g. lower policy interest rates) and expansionary fiscal policies (e.g. higher government spending). For example, during the GFC in 2008-2009, the Fed steeply reduced the Fed funds rate from 5.25% to a record low of 0.25% while the U.S. government rolled out fiscal stimulus measures to help the U.S. economy recover from the GFC.
With inflation currently at its highest level in four decades, the Fed’s aggressive tightening of interest rates to curb inflation may cause its economy to slow more than expected.
In the event that the U.S. economy continues to soften, the Fed could slow the pace of its Fed funds rate hikes, take a pause, or even start to reduce the Fed funds rate.
The U.S. government may also introduce new fiscal stimulus measures should its economy experience a hard landing. For example, during the Covid-19 pandemic, the U.S. government unveiled a total of US$5.5 trillion worth of fiscal stimulus to help boost consumer and investment spending in the U.S.
6. Equity investors should stay invested for the long run
Whether in a soft or hard landing, equity investors should stay invested throughout the economic cycle. In the last three decades since 1990, despite several economic and financial crises, the global equity markets (as proxied by the S&P Global 1200 Index) have recovered from short-term market setbacks (Figure 3).
Expectations for a soft or hard landing for the global economy can affect the equity markets in the near term. Nonetheless, as equity markets tend to reflect the underlying fundamentals of the economies over the long term, investors in equity funds should adopt a long-term investment perspective to stay invested by practising Ringgit Cost Averaging (RCA) to ride through the economic and market cycles.