Economy faces long-term infection from coronavirus crisis
The last seismic event to hit the global economy and financial markets was the 2008 crisis. The coronavirus pandemic crisis is much bigger, wider, deeper — and there are plenty of market commentators and pundits stamping this message into our psyche.
Veteran investor Glenn Silverman, CEO of GS Investment Services, believes its effects could be with us for a generation. In a RisCura webinar, called “Covid-19: A global reset with a generational impact”, he warns of its pervasive effects.
I have been cautioning that markets were looking exceptionally frothy before the arrival of the virus and Silverman’s reflection endorses my stance. US corporate debt has more than doubled in the past 40 years, with much of that in recent years being spent on share buybacks, pushing metrics to even higher and more unrealistic levels.
The valuation gap on the S&P 500, being the difference between the level of company price earnings valuations and underlying fundamental earnings, reached a high in early 2020.
And yet analysts continued with their unrealistically high earnings expectations. Conditions were perfect for something to trigger a sudden collapse of asset values, marking the end of a growth phase in credit markets or business activity.
Silverman calls this the “Minsky moment”, named after economist Hyman Minsky.
Since this crisis began, governments have thrown increasing amounts of money at the situation, reducing interest rates to virtually zero in some instances. However, these intended solutions are worsening a longer-term problem. If debt was the main problem leading up to this crisis, then obviously more debt is unlikely to be the solution.
Leading pundits such as Silverman all shout how profound the effect of the virus and country response will be on employment, politics, logistics, corporate survival, financial regulation, state coffers and interest rates.
There will be fewer jobs around. Once corporates have got used to making do with fewer people, it becomes habitual. Even in China, where unemployment is rising, greater use of automation is being investigated.
At a social level, the return of the nation state and deglobalisation can be expected. Populism and nationalism were on the rise long before the pandemic but the fragility of economies in these conditions makes this more acute.
Supply chain management will change, with much more insourcing, including of commodity-type goods, and far less outsourcing to countries in Southeast Asia.
Companies with strong balance sheets will survive, while more highly geared entities face uncertainty. There will be beneficiaries, such as Amazon and home-delivery operations. Others will have to rebrand and reinvent themselves. Many will fail, depending on the duration of this crisis.
There may be a new era of financial repression, and notably in SA. Taxes will rise, exchange controls could return, and prescribed assets could well be reintroduced. State debt levels post-crisis will be unimaginably high, leaving many sovereigns around the world in a debt trap.
Interest rates are likely to remain even lower than anticipated before the pandemic, which makes SA government bonds look attractive right now, offering a real yield of about 6%. No other emerging-market instrument offers this type of yield.
So even though our bonds are excluded from the World Global Bond Index, unconstrained investors will find them attractive, especially in a world where the “Japanification” of bond yields could continue for the foreseeable future. Cash yields looked quite attractive immediately after the Covid crisis arrival, but rapid SA Reserve Bank cutting means the 10-year bond yield is double that in the money market.
Pre-virus, SA was already facing its longest business cycle downswing in history. Now, levels of uncertainty are unprecedented. Like other emerging markets, it cannot simply print money as the solution.
You may look to the low oil price as a rare positive, considering we are a net importer. But with demand evaporating, its benefits are lost, and to borrow a phrase from social media, it’s like giving a hairbrush to a bald man.
THERE WILL BE FEWER JOBS AROUND. ONCE CORPORATES HAVE GOT USED TO MAKING DO WITH FEWER PEOPLE, IT BECOMES HABITUAL