What could a post-Covid world look like?
Accelerated digitization was just the beginning.
It’s been just over a year since a mysterious new virus out of China first hit our shores. Before we knew it, the entire world went into a near synchronous global lockdown, spawning a global recession, bringing an abrupt end to what had been the longest economic expansion in modern U.S. history and sending our equity market into the fastest bear-market ever. With unprecedented global fiscal and monetary support, the market has more than recovered. But the ongoing effects of this deadly pandemic are creating potentially lasting changes in the way we work and live, some of which are recognized and obvious, others not so much.
The obvious? The rise of remote work, online commerce, fintech, bitcoin, investing apps, etc. Their acceptance and use exploded as shelter-at-home policies accelerated the digitization of the global economy. With costly and long commutes turning into trips from the bedroom to the den, many employees—and employers—have grown comfortable working from home and connecting remotely with colleagues. Confronting closed stores, bank branches and restaurants, consumers discovered how easy it can be to use smart phones, e-currencies and cryptocurrencies to manage their affairs and pay for and receive at their doors the food and products they want. Even investing seems effortless thanks to Robinhood and other online apps that provide user-friendly 24/7 access and trading.
Virtual world is now the real world
Indeed, as the virtual world has morphed into our real world, many of these changes will likely become more permanent. On the one hand, with pent-up demand and excess savings, who doesn’t miss eating out at a nice restaurant with family and friends, watching a movie on the big screen with a super-sized popcorn in hand, or going on that long planned, exciting trip abroad? But it seems clear that many of these “new” realities will remain a part of our daily lives going forward. Companies almost certainly have come to appreciate the savings and efficiencies that come from requiring less office space as employees work from home or even in different cities and states. Growing investment in technology and automation will certainly follow. As the virus fades, these work-life adaptations promise productivity payoffs as older ways of living and working fade away. In our dynamic economy, there will always be change.
If we step back, it’s also interesting to think of broader transformations that may come to pass in a post-pandemic world. Starting in the late 1970s, three key forces that have shaped the global economy for the better part of two generations—shrinking government, the rise of globalization and disinflation—may well have reached their inflection points, with Covid-19 working as the catalyst that moves us into an entirely different paradigm:
- “Big government” is back. Ever since Reagan’s famous “nine most terrifying words” speech, “I’m from the government and I’m here to help,” government arguably has been viewed more as an obstacle than a partner. This trend was global but especially apparent in America. Then the pandemic hit, and almost overnight, government was compelled to rush into action, passing massive relief efforts. Several trillion dollars more are almost certain based on what the European Union and U.S. governments have in store. An explosion of global debt materialized overnight. It’s not just in the West but also in the emerging countries. Fiscal stimulus and related policies to combat the virus added $19.5 trillion to global debt last year, according to Institute of International Finance estimates, pushing overall global debt to a record $277 trillion, according to Bloomberg News. Such fiscal activism hasn’t been seen since World War II as countries act not only to fight the virus but also to support businesses and households impacted by it through direct payments, foreclosure and eviction moratoriums, child and food aid and other measures that break with the small government mold. Given the push by the Fed, Congress and the new administration, it appears this era of bigger government will remain a fixture in the U.S. for some time to come, mirroring what’s also transpiring in Europe: a desire to save jobs, assist lower-income households and invest in infrastructure and green technologies. At the same time, global central banks continue to expand their already stretched balance sheets. As of this writing, the Bank of Japan, for example, already owns close to 6% of the Japanese equity market. The bottom line is that the role of the state will increase everywhere in the world.
- Globalization gives way to regionalism. The globalization wave that benefited investors, companies and consumers over the past 40 years appears to have crested. And while globalization won’t be going away, it will be taking on an entirely new and different look. In its place, we expect to witness the emergence of regional economic, currency and standardized technology zones: Asia, the Americas and Europe, with the rest of the world up for grabs. Supply chain disruptions spawned by the rise of trade wars and populism were brought to the fore during the pandemic, prompting companies to consider reshoring operations and building new, closer-to-home networks with regional partners, especially in the critical health-care sector. At least some of the jump in capital expenditures by companies over the past year reflects this trend. Both Samsung Electronics and Taiwan Semiconductor have announced plans to build billion-dollar chip-making facilities in the U.S. We believe this will pick up steam, potentially incentivized by “Buy American’’ policies of the new Biden administration but mainly because of problems associated with relying on far-flung supplies that became so obvious in the fight against Covid, such as difficulties securing personal protective equipment, ventilators, pharmaceuticals and other medical supplies. Layered over this is a shared desire among governments to have greater control over technology and future economic drivers: artificial intelligence, 5G communications, automation and other digital technologies that are prone to cyberattacks and espionage in an increasingly virtual global economy where the interests of China, Russia and western Democracies often conflict and diverge. Globalization isn’t dead, it’s just different.
- A little inflation’s not so bad, but... President Reagan’s arrival in 1981 coincided with the work of Fed Chair Paul Volcker to bring runway inflation under control. The 40-year war on inflation was launched and proved successful—almost too much so, in the view of today’s Fed and other central banks. Fearful of the disinflationary outcome that has bedeviled Japan since its asset-bubble era burst at the end of the 1980s, Fed policy now aims at allowing inflation to run a little hot, i.e., above its 2% target, with a goal of lifting its longer-term average to the desired 2%. The worry is that it may be too successful. This policy shift comes amid a run-up in commodity process and pent-up demand, and rising global debt and deficits that historically have tended to precede breakouts in inflation. True, the experience of the three years before the pandemic hit, when deficits soared, the economy grew robustly and unemployment hit a 50-year low but inflation remained mired below 2%, suggests this concern may be overdone, particularly given productivity also lagged during the period. Still, if globalization eases and supply bottlenecks ensue, the potential for a spike in prices isn’t out of the question, in spite of the ongoing deflationary forces and the acceleration of automation and productivity. We’ve already seen it in recent months in energy, metals and many agricultural commodities, not to mention housing, where prices are rising to new highs amid tight supply. The market isn’t currently expecting nor pricing in a surprise inflation breakout. Time will tell.
So, how should global investors prepare for this post-Covid world? Longer term, greater government influence and potentially higher inflation rates may negatively affect investment returns. In the nearer term, we believe emerging markets (EM), especially those in Asia, are best positioned. China’s was the lone economy to grow last year, and that growth looks to be accelerating, spilling over to the broader region. EM countries also stand to benefit most from a global synchronized economic boom, rising commodity prices and the past year’s weakening dollar, a trend we expect will re-emerge after recent strengthening amid rising Treasury issuance to finance a deficit now running above $3 trillion annually. Further out, it’s more a case of wait-and-see. Three powerful forces that have shaped much of the investing world over the past four decades may well be turning on their head. While it’s too soon to know how this all plays out, we do know that life as we knew it before Covid may never be the same.