The Long View
A POST-PANDEMIC WORLD
COVID-19 transformed the world in 2020. How might this new world ultimately look?
The most remarkable thing about the markets this year is that if you went to sleep in January and woke up at the end of June, you would not know, from looking at your portfolio, that we are in a health pandemic – arguably, the most significant health crisis in 100 years. Granted, it’s not been a smooth ride, with stocks dropping 35% in a few short weeks before staging an exceptional recovery.
Clearly, the enormous financial intervention of central banks explains much of the rebound in stocks from their March lows. The Fed has acted with uncharacteristic speed to prop up the economy, shore up credit, and bolster the financial markets. “Don’t fight the Fed” is an adage that fits like a glove in today’s market environment.
Yet, the economic and market outlook remains uncertain. In normal times, the economy is driven by a dynamic process with multiple factors interacting to set prices for stocks and bonds. Today, nearly everything hinges on the health data. Stocks rebounded based on a drop in COVID-19 reports after the lockdown; the recent weakness in stocks began as cases accelerated again.
MANY QUESTIONS – FEW ANSWERS
How will the world be different after the pandemic? There are more questions than answers.
How quickly can the virus be brought under control?
How will the current spike in cases play out, and will a second wave emerge in the fall and winter?
When will an effective treatment and vaccine be developed and available?
How long will it take for confidence to return and normal spending to resume?
How will businesses that require person-to-person interactions fare over the medium and longer-term?
Forecasting is difficult even in “normal” times. These questions don’t have readily available answers; therefore, modeling outcomes is filled with guesswork.
WHAT WE KNOW – WHAT WE DON’T
One thing is certain: the world will emerge from the pandemic with much more debt, both public and private. The U.S. Federal Reserve’s balance sheet, which shows the means the Fed uses to inject cash into the economy, now stands at $7.1 trillion, having grown by $3 trillion since mid-March. At this pace, it could conceivably approach $10 trillion by the end of the year.
The pandemic also forced much greater U.S. Government fiscal spending ($2 trillion+) even compared with the financial crisis, raising the question of how this debt will be managed and repaid. The long-term implications of all this new debt are the subject of a future letter. In the meantime, interest rates will likely remain very low for some time, making the debt more manageable for now.
Even with a vaccine that brings the disease under control, will people go back to the lives they lived before? Our guess is they will return to restaurants, shops, and some travel, but not entirely and not like before. Without a significant pickup in consumer demand, inflation will also stay low.
Many businesses will fail. According to The Wall Street Journal, the coronavirus will finish off the retail reckoning that Amazon started, with up to 35% of retail and shopping closures becoming permanent. Over 50% of the restaurants may not reopen.[1] The travel and lodging industries are likely changed forever.
The austerity movement for countries to pay back debt and move toward balanced budgets, such as in southern Europe and to a lesser extent in the U.S. after the 2008/09 crisis, will not likely be repeated. A new collective consciousness could emerge in the U.S., not unlike what happened in 1933 and again after WW2. As a result, taxes may rise for everyone, but the wealthy will likely be most impacted. This may not all come in the form of traditional hikes on income, capital gains or a wealth tax. Like much of the rest of the world, the U.S. may end up with a value-added consumption tax. It could also come in the form of a weaker dollar and higher inflation, which essentially devalues the debt over time.
Globalization and multi-country supply chains face increasing resistance, as the coronavirus has reinforced nationalist sentiments. The truth is, we trust other countries, even traditional allies, even less than we did before the pandemic. Consumer prices for imported goods were already rising as a result of new trade restrictions and tariffs. That trend could increase when consumer demand picks up.
THE IMPACT ON YOUR PORTFOLIO
Near term, the markets will continue to be buffeted by health data and vaccine news.
Longer term, it’s difficult to envision a scenario where bonds match historical returns of 5-6% for fixed income securities. Income yield is low due to unusually low interest rates, and there is hardly much room for capital appreciation normally expected from falling rates.
The same improving economy that would support stock prices could have the opposite impact on bonds. Reaching for yield, either through longer maturities or lower credit quality, is risky both if the economy grows more than expected (resulting in higher rates and lower bond prices) or experiences a deepening recession (with more credit problems). The best course for investors, we believe, is to focus on high-quality bonds and manageable durations. Some allocation to inflation-protected securities makes sense as a hedge against a longer term, rising inflation scenario.
Stocks will continue to drive total portfolio returns. After a long period of under performance compared to U.S. firms, international companies are attractive, a view that reflects their lower valuations. In the U.S., the Nasdaq market continues to outperform due to its heavy weighting in technology and internet-based firms that have been favored during the stay at home movement. That could continue, but not forever. A globally diversified and balanced approach can provide returns and help manage risk.
How much risk is enough? For many investors, a tilt toward stocks still makes sense. The traditional 60% stock/40% bond portfolio should continue to provide a good balance of growth and stability. As always, the final decision is based on your unique needs and circumstances.
Finally, when it comes to market timing there are only two types of investors: those who can’t do it, and those who know they can’t do it.
[1] “Coronavirus Finishes the Retail Reckoning That Amazon Started,” Wall Street Journal, July 6, 2020
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