06 August 2020
Alex McKnight anticipates a return to growth tinged with a permanent impairment of the economy due to lost consumption.
Even if there is a second wave of infections, will we remain out of lockdown?
Given the experience we have had so far, the lockdowns that we had starting in March are likely to be a thing of the past. This has been a learning experience for everyone; some countries faced it well, others not so well. The one message overall is that we cannot close everything down, and more importantly, there is not a need to close everything down. The governments that reacted quickly are better positioned to implement a track and trace method. In the future, it will be more likely we hear not that an entire country is locking down; we will hear that a specific region is locking down. It will be very specific, as track and trace will continue to get better, especially as winter grows closer. Covid is here to stay with us for quite some time – we could easily be looking at two years of the world fighting this virus prior to a vaccine. For now, getting better at track and trace and localised lockdowns will allow countries to avoid the mass incarceration of entire populations that we have seen before.
Are we entering a return to growth phase for markets and economies?
Returning to growth is an interesting question. The obvious answer is yes, but the problem is that the global economy went into a deep freeze and some things will never be the same again. The holidays and meals and haircuts that were missed will not happen again; only one hair cut is needed after four months of isolation. Travel agents, airlines, bars, restaurants, hotels and others will need to contend with consumption that is potentially lost forever. A ‘V-shaped’ recovery does not necessarily mean we rejoin the previous path that existed, rather it could mean that at best we make up for the consumption that we wanted to do and then over time rejoin. There are jobs that are lost forever, however. We are returning to growth, but there is a permanent impairment of the economy that will never be recovered.
What does this mean for your asset class?
Fixed income started the year expecting rates to be higher – primarily long-term rates. That is no longer the case, nor will it be any time soon. We sometimes wonder if positive rates will be seen in Europe again any time in the mid-term future. The reality now is very different from 20 years ago, as we are looking at zero rates for what feels like forever. What does that mean? We do not have a threat from duration just yet, while inflation is finding its wings. If we hold rates at zero, there is a chance that inflation will be provoked, which could be a worry down the line. It could mean a bifurcation in credit; good borrowers could find cheap money for a long time. At the other end of the spectrum, the credit spreads for refinancing risks could be significant for structurally challenged industries.
One of the things Covid has done is accelerate trends that were happening already. The high street was already on its knees, and it is now effectively dead. The energy sector, similarly, was seeing a shift towards green, and that has now been encouraged dramatically. Ironically, non-ESG businesses would have a preponderance towards airlines and energy, which are areas which have been dragged down by the pandemic. We are seeing fewer opportunities in the old economy as far as credit is concerned, and bifurcation is coming through. There are potential rewards to be had in the corporate space in Asia versus developed markets; BBBs in that space have already taken back half the spread. The asset-backed space has also taken back most of the losses it incurred, as those were mostly liquidity driven rather than based on fundamentals. Underlying all of this is the fact rates are zero. Those companies which can refinance will be able to do so cheaply for a long time, and their businesses could thrive.
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