7th May 2020
In March, a leaked Public Health England (PHE) document stated that the coronavirus epidemic could last until next spring and might infect as many as 80% of Britons over that time period, resulting in a far higher death toll than recorded to date. Government officials have downplayed this outcome as the worst-case scenario. More optimistically, scientists are racing to produce better treatments for current patients and, separately, to develop a vaccine that is effective against the disease. In the meantime, governments around the world must make difficult choices about how and when to ease the lockdowns that have frozen large parts of their economies. For investors, the timing and shape of the economic recovery are very uncertain. We think it is likely to be more of a U than a V-shaped recovery. The longer-term implications of the current crisis are also subject to debate. Be that as it may, we believe that now is the time to flag where we see the most significant areas of change.
Impact on economic growth
In the medium and longer-term, economic growth faces several headwinds from the current crisis. To begin with the lockdowns have been a massive shock to governments, companies and consumers. Governments have stepped in to provide fiscal support while central banks have further eased monetary policies. However, these steps may prove to be temporary as the authorities only have so much ‘ammo’ to spread around. Once the recovery is underway, these policies may by necessity gradually be phased out. At the same time, various microeconomic programmes, have been implemented to cushion the blow to certain sectors, often following stringent lobbying from the relevant industry. There is a risk that these interventions end up supporting ‘zombie’ companies and prevent market forces from operating efficiently. As Milton Friedman once famously remarked, “Nothing is so permanent as a temporary government program.”
Company management have also been stunned by the speed with which the crisis has unfolded. There has been a scramble for ‘liquidity’ as management have sought to slash costs, furlough workers through government schemes and put capital investment on hold, in order to preserve cash and keep their company solvent. Given this cathartic experience, it seems reasonable that management teams with the full support of shareholders will manage the debt leverage of their companies in a more conservative manner in future. This structural deleveraging will act to constrain economic growth. As noted below, a further hit to growth may come as companies create more resilient, but costly supply chains.
The future behaviour of consumers is a big unknown. As we argue below, there are likely to be shifts in spending patterns, but the key question is whether consumption in aggregate falls below previous levels. If consumers feel a bit more risk-averse, and who can blame them, they may wish to save a bit more and spend a bit less. Whilst entirely logical, in itself, such behaviour may restrain economic growth (it should be noted that this inference is itself the subject of a lengthy debate in economics).
Impact on globalisation
The virus has revealed the fragility of global supply chains. Some companies may decide to onshore more operations while governments are likely to support local businesses that can supply the most critical items, especially for healthcare purposes. These trends could reinforce signs of fragmentation of the international trade system as evidenced through trade disputes such as that between the US and China. In this scenario, global trade may be slow to recover from the coronavirus crisis. The other elements of the globalised economy may also come under pressure. International patterns of migration, both short and long-term, are also likely to be slowed as governments maintain some of the current controls and restrictions on the movement of people. Lastly, there may also be some long-term impact on international capital flows although this is not yet clear.
Impact on consumer spending
Coronavirus has led to significant short-term changes in consumer spending. Some of these have been mandated by governments. Travel restrictions have closed international tourism (travel, hotels, casinos, etc) completely while local lockdowns have shut the leisure industry including restaurants, bars, cafes and cinemas. By contrast, grocery store spending has boomed with the stockpiling of some items reaching unprecedented levels. Once the economy re-opens and restrictions are eased some of the old spending patterns will surely return. However, it seems unlikely that international tourism will recover to anything like its previous level for many years to come. Countries will operate much more stringent and time-consuming border checks, while consumers may adopt more risk averse attitudes to travel and leisure pursuits. Until a vaccine is developed there may be legal restrictions on spacing in many public places. As mentioned earlier, consumers may feel they want to hold a larger ‘rainy day’ fund and so the savings ratio may increase.
Impact on dividend payments
We estimate dividend payments in the UK will fall by more than one-third this year, with a similar level of decline from international equities. Thereafter there will be a recovery. However, as already noted, management teams may seek to build more resilient businesses and seek to retain more cash. In this model shareholders may have to get used to receiving a structurally lower level of dividends in favour of, hopefully, more resilient investee companies. Note for UK equities, we still expect a rebased dividend yield of around 4% which is still well above the level that can be obtained from cash or gilts.
Impact on healthcare spending
In a 2015 TED talk, Bill Gates, co-founder of Microsoft, warned that the biggest threat to the world was from an epidemic rather than a war. Gates strongly advocated that governments boost healthcare spending to create a “global alert & response system”. Unfortunately, Gates’s words fell on deaf ears but looking forwards it seems very likely that one of most obvious effects of the coronavirus crisis will be a structural rise in healthcare spending especially on areas like vaccines and diagnostics.
Impact on working habits
The various lockdowns across the globe have led to a dramatic change in working practices. The epidemic has forced many people, who previously worked in the office, to work on a full-time basis from home. Once workers have made it through the adjustment phase, which has included learning new ways to communicate (Zoom et al) and new ways to co-ordinate work with colleagues (Teams, etc), they have generally found they can be as productive as they can working in an office. Of course, this is not true of every industry (it is far less relevant to retail, leisure, transport, manufacturing or agriculture) but for many service companies the experience has been revelatory. Some companies are now openly talking of downsizing their office space in future with some staff members working from home for at least part of the week. This clearly has implications for the commercial property market.
Impact on debt and inflation
In the short term, the coronavirus crisis is having a deflationary impact as economic activity contracts. Over the longer term, the debate over a possible resurgence in inflation is more interesting. On the monetary side, the scale of the stimulus from central banks is unprecedented. For example, the Federal Reserve bought more bonds in March than it did during the whole of the Global Financial Crisis under the mantra of doing ‘whatever it takes’. To date such Quantitative Easing (QE) has not resulted in the higher inflation that many commentators predicted it would cause, but we are entering uncharted water in terms of the scale of the stimulus. We mused earlier that governments and central banks would remove the stimulus package that they are currently pursuing, once the economic outlook improves. This may be correct but consider the alternative scenario - if these expansionary measures are kept in place too long, then surely the risks of higher inflation will return. Given the very high debt levels that governments will have to grapple with after the pandemic eases, inflation might also appear to be a reasonable option for policy makers as the public’s appetite for ‘austerity’, as a method to pay down this debt, appears to be relatively slim.