The near-term implications of the coronavirus outbreak and ensuing global recession are still so uncertain that it is tempting to focus solely on the outlook for the rest of the year rather than the rest of the decade.
But as long-term investors, we know it is more important to understand the direction of the market than its daily or monthly movements. So what comes after the recovery? I believe that this crisis will not so much transform the world as accelerate the trends that were already reshaping it.
We have been discussing a new political paradigm since 2016, the year of the Brexit referendum and Donald Trump’s election. At the dawn of this populist era, I highlighted an academic paper by Funke, Schularick and Trebesch that found that, after a financial crisis, voters seem more attracted to extreme right-wing ideas and rhetoric.
Seeing a market crash occur alongside a pandemic, I also recommend the very topical but similarly depressing research of Kristian Blickle at the New York Fed, who has documented a positive correlation between deaths from the Spanish flu and the Nazi party’s share of the vote in German municipalities during the 1930s.
We very much hope never to see such extremism again – and perhaps furlough schemes have averted the worst political consequences of mass unemployment – but we cannot overlook the gains now being made in polls by far-right parties like Brothers of Italy.
Importantly, such politicians do not necessarily have to win power to matter to investors; they just need to move the Overton window of policies that are acceptable to electorates. For example, just the threat of rising populism in Europe could prevent much-needed progress from being made on debt mutualisation in the single-currency area.
Equally, mainstream parties could become hooked on the greater fiscal spending integral to the COVID-19 response, as politicians attempt to buy support and central bankers gradually lose their independence. This would be very inflationary over the long term, in our view.
Furthermore, the massive borrowing spree underway will most likely kick-start economies. But it could in the longer term lead to a “balance-sheet recession” like the one suffered in Japan, as a subsequent focus on paying down debt hampers growth. State intervention also generally lowers productivity and encourages the misallocation of capital, supressing trend economic growth and average real returns.
From crisis, opportunity
It therefore feels like we are not so much near the end of the present COVID-19 crisis, as at the beginning of an exceptionally tumultuous period in global markets and geopolitics. But as investors we must nevertheless look for opportunities as well as threats, and I have no doubt that the upheaval will present plenty of both.
For example, a balance-sheet recession would typically be associated with a trend towards less corporate leverage and lower pay-outs. This should be positive for credit, assuming the wave of defaults and downgrades is fairly priced.
In equities, we believe we are entering an environment in which technology will be seen as a strategic industry and where its growth, pricing power, cashflows, automation and limited supply-chain complexity will come at a premium.
Our longstanding approach of “prepare, don’t predict” is likely to prove more valuable than ever as we contend with these forces shaping the world for better and worse.