What a year it has been. If asked to describe the year past, “unprecedented”, “extraordinary” and other words of the same ilk would be used by all and sundry.
It could quite possibly be that we are, at this very moment, witnessing a turning point in history. Whether we are or not will be evident in the future, but the events of the past year have caused a shift in our collective thinking, prompting us to identify what we, as a society, consider as important for us as a species.
Looking back over the past year, all the events seem to blur into one big event – Covid-19 and its fall out. The rumblings were being heard of a SARS-like contagious disease being detected in China.
By the end of January 2020, the pandemic had reached European shores, with the first cases being detected in the Italian Alps as well as in the UK. During the “first wave” of restrictions, “R number” and “flattening the curve” became household terms, with (often armchair) data analysts waxing eloquent about how to model the number of people falling ill and how to reduce that number – often providing more advice than medical practitioners.
Soon, governments across the globe had done almost the unthinkable – they shut down the economy. Everyone was instructed to stay at home, apart from essential work and purchases, with many categories of retail businesses closed.
Shutting down economies came at a cost. Severe reduction in consumption and activity created an aggregate demand shock, causing GDP growth to turn negative. Imposed, as well as voluntary, restrictions on mobility wreaked havoc on certain sectors like retail, hospitality, aviation and travel. In other areas, changes to consumer preferences, along with technological advances, prompted a re-think of existing business models and supply chains.
As economic activity ground to a standstill, governments engaged in a concerted programme of fiscal stimulus, ranging from cuts and moratorium on taxes and furlough schemes to support payments being paid directly to individuals. The extent of such schemes dwarfed the fiscal stimulus provided during the financial crisis of 2008.
To put it in numbers, the UK spent 1.5% of its GDP during the financial crisis and 5.1% of its GDP during the pandemic. The corresponding numbers for the US were 5.9% and 11%. However, as restrictions were eased by governments (either by choice or demand), consumer mobility did not improve, and consumer consumption moved online – much to the detriment of the retail sector.
In the UK, some of the best-known retail stores, like Debenhams, closed their doors amid profit warnings from other retailers. In addition, the hospitality sector has been shedding jobs, putting more than 20% of its workforce at risk. And all this notwithstanding Brexit hanging over the UK like the Sword of Damocles.
Fast forward to December – the mood has changed. We have, not one, but two vaccines for the virus and the roll-out to the general populace has begun. We have a Brexit deal, of a kind. And – we have a new president for the US. The green shoots of optimism are there. The mood is reflected in the buoyant markets, with the Dow and the S&P 500 as well as Nasdaq breaking records. Even the beleaguered FTSE 100 managed to move higher in the last few trading days, post the Brexit deal. But why does it feel that we are not completely out of the woods yet?
The most ambitious global vaccination programme is on its way. In the UK, Eurozone and the US, the first doses of vaccines have been rolled out. At this juncture, it is important to stop to consider the speed at which this vaccine has been developed. It took us, working in a co-ordinated manner, just 11 months to develop. However, the large-scale manufacture and global distribution of the approved vaccines is another matter. The scale of the endeavour is enormous, but as they say, every journey begins with a single step.
While the developed economies may be vaccinated completely by the end of 2021, global vaccination will take longer. However, the virus has shown that it is capable of mutations into different strains, thereby implying that it is going to be with us for longer and the risk of periodic but smaller outbreaks remain.
The global economy, which was in deep recession only recently, will start to grow, albeit in a muted manner. Though the wheels of the economy will start to turn, we expect global growth to be below the 3% level. The expansionary monetary and fiscal policies will benefit demand, but strains on the global supply chain will remain.
Monetary and fiscal policy will remain the safety net for growth and financial markets, but some measures like furlough schemes and moratoriums on interest and tax payments will tend to roll off. This may cause an increase in insolvencies, which could have adverse implications of employment, especially in the developed economies. To support the measures, government borrowing will continue apace, with interest rates remaining low for the foreseeable future. The spectre of inflation will remain, as Central Banks are more willing to let their respective economies run a bit hot, rather than reign in the accommodative fiscal policies.
2020 was a sobering year – we found that an existential threat to our way of life can focus the mind on priorities.
Discrepancies in wealth, racial discrimination and climate change have been brought to the forefront of our minds. There is an increasing trend in measuring investments, not only in terms of performance or returns, but also in terms of wider Environmental, Social and Corporate Governance (ESG) goals. There is an increased demand for ESG linked issuance, as well as more pressure on companies on ESG disclosures. The age-old adage of “do good to do well” has finally come home to roost.
ESG driven and sustainable investing will become the norm rather than an aspiration. However, there is a conundrum: barring dramatic policy and technological breakthroughs and corporate action, the availability of investment opportunities, which match these goals will become increasingly limited with each passing year as the required incremental action will be harder to achieve. Thus, investors may need to engage with companies and actively modify their business models to align the investments with their own objectives.
Given the depths we plumbed in 2020, we look forward to the new year with cautious optimism. The macro environment favours risk taking. However, the price of risk in risky and safe assets have been contorted over time, partially due to the easy monetary conditions.
While on the one hand, risky assets, like equities, corporate bonds, emerging markets equities and bonds are not priced for a deterioration of current economic conditions, on the other hand, safe-haven assets like sovereign bonds in the developed world are not priced for an improvement of the economic environment.
A macro environment such as this favours a risk targeted approach to investing, rather than chasing returns. Thus, formulating a longer-term view and objective, with a clear eye on risk and sustainability, will help in providing a smoother glide path for investments.
Abhi Chatterjee is chief investment strategist at Dynamic Planner
