Investing in a post-Covid-19 world

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Earlier this month, BNY Mellon Investment Management’s chief economist Shamik Dhar spoke with Newton Real Return investment leader Suzanne Hutchins to get her take on central banks’ responses to the Covid-19 crisis and how investors can best navigate towards a post-pandemic world.

Shamik Dhar (SD): How do you think central banks have handled the crisis so far?

Suzanne Hutchins (SH): I think they’ve done as much as they possibly can to support the financial system. After the GFC (global financial crisis) in 2008, they were prepared for a financial crisis to happen again. With that experience to guide them they’ve supported asset markets pretty well in my opinion. 

In terms of the financial markets, central banks have probably done all they can, but it’s the real economy where there’s the challenge.

SD: I agree. I also agree that Monetary Policy isn’t really the tool that’s going to get us out of this. It’s all about the health and fiscal policy isn’t it?

SH: I believe so. Most people can agree that quantitative easing (QE) over the last decade hasn’t really worked in terms of stimulating the real economy. What it has done is inflate financial asset prices, and caused significant capital misallocation. So in our view, there was always an expectation of more needing to be done. We thought along the lines of Modern Monetary Theory (MMT), with a fiscal response combined with a monetary response. We didn’t know what would be the accelerator for that, but in the end the Covid crisis was the catalyst.

SD: Yes, I agree. You do hear that complaint as well that the marginal impact of every additional dollar or pound of QE seems to be diminishing over time. When you get shocks like this there are limits to what QE can achieve.

With some of the unexpected consequences of QE, people have talked about higher inequality and such. Do you think this is set to worsen that or do you think people will be focused on other issues?

SH: The policy response and amount of state intervention we’ve seen does exacerbate the situation between the haves and the have-nots. The financial market needed to be supported, and if the financial markets had collapsed then the global economy would have been in a much worse shape than it currently is.

So, for now, we’ll still get that inequality. We’ve already witnessed social unrest and people being unable to finance themselves and get help. There’s a big world divide but I think the policy of MMT or a fiscal response could address some of that. The fact that environmental, social and governance (ESG) issues are in the spotlight now more than ever, it’s a good thing and I think it will drive financial markets from here.

SD: I agree. Major economic shocks like this are turning points in social narratives and eventually in terms of policy as well. I think ESG will take more of a centre stage.

Do you think there are particular opportunities the crisis may well have opened up? Are there parts of the market that might expect to respond better than others? How do we invest our way through this?

SH: Wherever there’s crisis there’s opportunity.  Volatility in markets is creating that opportunity. I think the one challenge that I have as an investor is that you’ve got central banks that are effectively managing the markets, and the read-through in all of this is that we’ve got debt monetisation going on, very low interest rates, and QE that appears to be infinite which is a massive support for financial asset prices.

The trouble is on the flipside. I’m quite torn because valuations across nearly all financial asset prices are pretty extended. Price/earnings multiples are in excess of where we were back in February since earnings have been downgraded so substantially. It is a tug of war between Wall Street (financial markets) and Main Street (the real economy).

In that sense it’s very much an active stock picker’s market. I do think there are certain companies and businesses that will really benefit, with the strong getting stronger. There are companies that benefit from the post-Covid crisis, whether it be the healthcare sector or in distribution, transportation… but there are also other areas of the market I’d avoid. Specifically aviation, you don’t need to necessarily get involved. But there are other asset classes that are interesting. If you look at investment grade bonds and buy what the Fed is buying, for example, you don’t get a massive return but get a better return than you do on cash. 

Areas like high yield, I think, are going to be quite troubled, particularly where there are businesses with stretched balance sheets and cash flow issues. I also think emerging markets ultimately will be great beneficiaries over the longer term because that’s where the world’s wealth is growing fastest, that’s where you have the massive populations and in 10 years’ time, I certainly think that is the place where investors are likely to be well rewarded. Weakness in the US dollar is supportive of this region.

SD: That’s interesting. I think there’s lots to think about there. I’m torn as well because on the one hand I can see good fundamental reasons why valuations could be higher than they were in the past and that’s because real interest rates, the safe discount rates we apply to risky assets, have fallen so dramatically and probably into negative territory in large parts of the world.

On the other hand, the risk premium, it does seem to have fallen a bit too much given the uncertainty on where we go next on Covid-19.

I suspect you’re absolutely right and there are huge stock and sector selection opportunities out there. I think that’s where a lot of the additional value might be going forward.

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