What will investing look like after COVID-19?
Even in the fog of war against the virus, the coming investment landscape is beginning to emerge.
Despite fears that “the world will never be the same” after the threat of COVID-19 has passed, less may change for investors than many assume.
In fact, we’ve identified seven key features of the investing landscape important to investors and expect most either to remain much the same or to accelerate—with only two changing markedly:
Much the same
1. The cycle we are about to start will have many of the same characteristics as we saw in the prior cycle.
We face a deep recession and hard road to recovery. The likely result will be reasonable but not spectacular growth, gradually rising earnings, rapidly subsiding corporate default rates as growth is re-established, very low bond yields, and eventually, a return to full employment. This is what we witnessed for much of the last decade. Hence, although markets have moved a lot on the last few months and our forward-look expectations for market returns in the next decade have changed, the relative returns between asset classes in that period have not. We continue to believe:
- Private equity will be the highest returning asset class
- Cash and government bonds will struggle to keep up with inflation
- Listed equities will perform somewhere in between these two
2. Low inflation is likely to continue.
Once the coming recession ends, it is likely wages and prices will be kept from rising rapidly by the global “output gap”: the difference between what the economy might potentially produce versus actually produces.
As in the prior cycle, tech-led disruption will remain rampant, dampening firms’ ability to raise prices. Another deflationary influence: increased savings; after the pandemic’s economic shock, both households and businesses are likely to hold onto more liquidity relative to their incomes.
There will be pockets of inflation, notably in food prices—which will be felt in emerging markets, where food is a large part of consumption baskets.
Likewise, inflation might be present in parts of the manufacturing chain, but there is no guarantee this increase will show up in final prices. Even if it did, inflation indices in most developed economies have a larger weight to services than to goods.
Policymakers in the developed world will likely maintain exceptionally low policy rates for years (as they did in the last cycle). Debate over those mandates will intensify. And, as in the last cycle, all the asset-buying from global central banks will likely inflate assets more than consumer prices.
Even if you are convinced inflation will remain low, you still may be wise to fortify portfolios against the potential of rising prices. To do so: a first stop would be equities, which should perform well if demand pushes up prices.
If you believe inflation is a real risk, commodity exposure and inflation-protected fixed income may be part of your solution.
3. Expect geopolitical tensions to increase and supply chains to get even shorter.
Thanks to the recent trade war, firms already were questioning China-dominated production. The pandemic is likely to further pressure corporations to consider a supply chain either in their home country or in a closer, more stable trading partner.
There will be clear sectorial differences: Recent evidence suggests tech firms are spreading out and diversifying suppliers rather than bringing production explicitly into their home countries.1 But governments seem set to pressurize the private sector for more domestic capacity—especially in mission-critical sectors such as healthcare.
Indeed, health concerns may magnify the developing conflict between China and the U.S., accelerating this phase of de-globalization,2 and creating a clear divide between the more free-trading liberal democracies and the autarky-inclined China bloc.
4. The mega-trends—digital transformation, healthcare innovation and sustainability–gain even greater traction.
- Digital: Clearly, the pandemic lockdown accelerated our move from the physical to the virtual world. Working from home is the new norm. More of our services are likely to shift online. The balance between city and country could shift, altering returns and players in the real estate industry. And, while many governments already were committed to building 5G networks, the crisis-inspired demand adds incentive.
- Healthcare: More focus will be on innovating to provide treatments and vaccines against viruses such as COVID-19. The increasing speed of development is impressive, underscoring the importance of active management when investing in the area. (See “Gene therapy’s potential to save lives and industry,” and “AI and Big Data: New tools in the fight against COVID-19.”)
Also, the fact that the crisis quickly overwhelmed many healthcare systems may spark building of intensive care capabilities across the developed world. Add aging populations to the mix and economies are likely devote a greater share of output to healthcare, prompting healthcare firms to seek treatments such as gene therapy that address diseases’ root causes. This is will be a tail wind to top-line revenues in much of the healthcare sector for years to come.
- Sustainability: Any on-shoring of production may reduce carbon intensity. The crisis also may be the making of ESG investing, as there is growing evidence that ESG focused funds outperformed during the COVID-19 bear market.
5. Wealth and income gaps widen on differences in government support and resilience.
For both firms and households, this crisis seems set to hurt the weakest most.
- Corporate America: Small businesses were running on slender finances before the pandemic; many could fold. Large businesses will struggle, but generally have more capacity to cut costs, raise bridge financing, and tap government programs.
- Households: The crisis and its aftermath are likely to further entrench an income gap across the developed world that already had widened significantly in recent decades. The top fifth are more often married, highly educated couples, working as high-salary professionals or managers, and living in Internet-ready homes that accommodate telecommuting. Most will earn steady incomes and can have necessities delivered through the crisis. These factors will likely leave them better prepared post-crisis than those struggling with employment loss and facing greater challenges maintaining their children’s educational progress.
6. Progressive policies and experts gain ground.
- Policies: The institutional make-up of the global economy will still reflect the ideology of market liberalism dominant for the past 40 years, but its edges may be softened if recent fiscal stimulus policies prove effective. Many of the new measures may be categorized as “progressive,” including paid sick leave and wage subsides. Expect greater government intervention in the markets and more calls for a new economic model in the Western world.
- Experts: The lack of preparedness for, and resilience in the face of, the pandemic may turn the political dialogue away from anti-elite populism back towards expert policymaking. This could allow countries to be better prepared for future pandemics, but also could mean a greater government role in the economy.
7. Fixed income will be reformed—but to what extent?
March 2020 saw a near-total breakdown of fixed income markets: not just the most risky, but also those for core government and high quality corporate bonds. In stressed markets, with few buyers present, dealer books fill up leaving dealers are unable to buy more and facilitate trading. The market is, in effect, broken from a lack of liquidity.
Sources: The Securities Industry and Financial Markets Association, Federal Reserve Bank of New York, Data is as of April 13, 2020.
*Note: dealer inventory levels and Corporate Debt outstanding indicated by the last available data in each year.
Description: Chart showing on left axis that dealer inventories have declined relative to the bond markets, shown by corporate debt outstandings on the right hand axis
If this issue is not addressed, every sell off could bring dysfunction requiring massive central bank intervention in the markets. Coming years may well see significant reforms. (See “Investment grade bonds have a problem the Fed can help solve.”)