Five consequences of coronavirus still affecting the capital markets
The pandemic is still ongoing but the capital markets are already looking to the future. Which trends are here to stay and which were solely attributable to the acute phase of the crisis? Five main consequences have already emerged. Andreas Köster, the new Head of Portfolio Management, provides his assessment.
Andreas Köster, Head of Portfolio Management and Chairman of the Union Investment Committee (UIC)
Temperatures are dropping and case numbers are rising. This situation is unlikely to change in the coming months. Although a second winter of coronavirus is around the corner, there are significant differences this time. For now, the vaccination programmes have managed to break the link between infection rates and the strain on the healthcare system. As a result, politicians are under less pressure to take action and strict lockdowns are less likely. For the capital markets, the acute phase of the coronavirus crisis is coming to an end.
Investors are therefore turning their thoughts to the post-coronavirus era. Which effects of the pandemic will be here for the long term and which are likely to disappear again? These questions will help to determine investment performance in the years ahead. Five main consequences are already foreseeable.
1. End of secular stagnation
The global economic engine has not really run smoothly since the start of the Lehman crisis in 2008. The main obstacle to growth was the structural weakness of demand. Consumer spending, capital expenditure by companies and government spending worldwide were not enough to allow full utilisation of available production capacity. Economists spoke of secular stagnation.
This phase is now drawing to a close, one reason being the paradigm shift in economic policy that is being amplified by the pandemic. Virtually all of the major economic areas have shunned the austerity mantra. Instead, governments are opting for growth stimulation (despite the resulting increase in budget deficits). Coronavirus support programmes have opened the gates for a rush of fiscal policy measures, whether in Washington, Berlin or Beijing. The social and political consensus is too strong for this trend to be reversed. The consequences include not only rising debt levels but also higher public-sector demand. This is particularly the case in the US, where President Joe Biden has unveiled an ambitious programme of investment.
Another factor is increased economic efficiency. More investment (e.g. in digitalisation) means higher productivity. We therefore believe that the US may experience a mini productivity boom, as it did between 1995 and 2005 when productivity increased by up to 3 per cent per year at times. To sum up, the consequences for the economy of stronger demand and greater efficiency are the end of secular stagnation and a higher trend growth rate.
2. Easing of investment conditions
All of this is bringing about a fundamental shift in the capital markets. After all, a higher trend growth rate means higher yields in safe havens, such as US and German government bonds. These assets are an anchor investment for many investors. If they generate sufficient returns, the prevailing investment conditions will ease. Climbing the risk ladder will become less attractive.
Does this mean that the low-interest-rate environment is about to end? No, because this phenomenon primarily applies to the US. In Europe, the potential both for higher growth and for rising yields is much lower. For euro-based, fixed-income-focused investors, internationalisation and diversification into other asset classes remain the key to investment performance. Any investors sticking only to the eurozone will be missing out on upside potential. Those who choose to, or have to, invest exclusively in bonds will find it difficult to generate adequate returns from a total return perspective.
Easing of investment conditions; continued financial repression
Yields on ten-year government bonds and inflation*
3. Corporate profits are becoming a significant driver of share prices
The outbreak of the coronavirus crisis sent companies and investors into shock. They were worried that many companies would be forced into zombification or even insolvency. It is almost two years since the first case of COVID-19 and it is now apparent how exaggerated these fears were. A number of sectors really did suffer badly, such as aviation and tourism. However, there has been no huge wave of insolvencies so far. In fact, many companies have increased their profits in impressive fashion. There are also no widespread indications of zombification.
We anticipate that this trend will continue. Many companies reacted quickly and resolutely to the crisis and adapted their business models. As a result, their profitability did not fall and, in many cases, actually improved, not least because government stimulus measures laid the foundations for substantial revenue growth. The prospect of a higher (nominal) trend growth rate entrenches this trend. From a price/earnings ratio perspective, share prices should be able to easily withstand the headwinds of rising bond yields thanks to higher profits. This means that profits will be more important than valuation for share prices. If a company is profitable, its share price will be able to rise. However, not every company will be able to benefit from this in equal measure. Security selection is becoming more important.
4. Digitalisation and decarbonisation are pushing up commodity prices
The pandemic has laid bare the need for digitalisation at all levels of society. This will lead to increased investment in this area. Moreover, contrary to initial expectations, sustainability issues have not disappeared from the public consciousness. Quite the opposite: The EU, the US and even China are demanding and supporting the decarbonisation of the economy in their fiscal programmes. This major shift will also be reflected in the commodities sector. Overall, demand for commodities is likely to increase and prices will probably climb. Commodities are therefore one of the favourites in the post-coronavirus era. But tomorrow’s winners are not yesterday’s champions, and differences within the asset class are widening.
Metals such as copper, lithium and nickel will see even stronger demand because they are needed in order to increase capacity for the generation and storage of renewable energies. This can already be seen with copper. An electric car, for example, requires around 83 kilograms of copper, which is four times more than a car with an internal combustion engine. Going forward, the excess demand for certain commodities is likely to result in a new super cycle. By contrast, the importance of fossil fuels, such as coal, oil and gas, is expected to wane.
Price rises reflect the progress of decarbonisation
Indexed performance (€)
5. No signs of stagflation
The pandemic has, by various means, brought an end to the previously prevailing trend of disinflation, i.e. continually declining rates of inflation. A major factor in this regard is that underutilisation of capacity in the economy has been eliminated thanks to increased demand. But other structural forces are also driving up prices.
As a result, coronavirus is ending the period of disinflation but not resulting in stagflation. This sometimes feared spectre from the 1970s will not make a return in the 2020s. Instead, we will again see ‘normal’ rates of inflation, particularly in the US. Average inflation is likely to be slightly above the 2 per cent mark in the US and slightly below it in the eurozone. Capacity on this side of the Atlantic will not be fully utilised in the long term. This will keep the upward pressure on prices in check, despite the structural forces that are driving inflation. In a nutshell, Lagarde is likely to keep the reins of monetary policy at the ECB loose for a very long time to come.
As at: 04 October 2021.