In mid-February, Apple warned the lockdown of its stores in China would impact profits. Its stock price fell by just over 1 per cent and stayed within range of all-time highs. That investors did not think through the potential international implications of the outbreak of the coronavirus in China showed a high degree of complacency, which in turn helps to explain the speed of the subsequent market correction. That Apple shares have recently traded within 15 per cent of their highs shows that complacency is still with us.
The coronavirus has brutally exposed the fragility of the global economy which prior to the crisis was characterised by a range of contradictory faultlines – all-time highs in the face of multi-decade record levels of indebtedness, aggressively active central banks in the face of stark wealth inequality, and low international productivity in the face of record high earnings per share for corporate America.
Faultlines
Many of these faultlines have deepened. Central banks, in particular the Federal Reserve, are now more deeply mired in markets. Debt levels (relative to GDP) are in train to rise from their highest level since the second world war to close to their highest since the Napoleonic wars. Earnings, investment and economic activity have, for the time being, been destroyed.
The coronavirus crisis has also catalysed a structural change in the world economy. In recent years, globalisation has been dwindling. For instance, trade was slowing, the institutions of the liberal world order under attack, and the flow of ideas across borders was stickier. The stress test of the coronavirus has crashed globalisation. Trade and travel will bounce back but will not be the same. There is, for example, widespread talk of the need to ‘bring production home’, and many rescue packages are aimed at bolstering ‘national champion’ companies.
Regional giants
The end of globalisation will be followed by a fallow, diplomatically noisy and economically frictioned period, which will most likely give way to a multipolar world order.
This multipolar world order will see a world dominated by at least three large regions, the US, EU, China (the India-Dubai region is a potential fourth pole) – who do things increasingly distinctively. If we take the internet for example, China has its own walled off internet, America owns web giants, while Europe regulates it. Finance is another example.
In this context, the post coronavirus crisis economy will present several large challenges to investors. The first is the end of globalisation. Once earnings and macro data volatility has died down, investors may well need to focus on the damage to supply chains from the economic nationalism that arises from the crisis. The associated risk is that in certain economies, consumers also begin to favour domestic over international brands.
Though the importance of certain sectors – notably anything to do with data, software or healthcare ¬– has been heightened by the crisis, the ‘country’ effect may become more prominent and interesting from an investing point of view. Though the coronavirus is a common, global problem there has been a wide variation in the ways in which it has affected individual countries and has been dealt with by them. In general, countries with strong institutions, high levels of trust and well-funded public healthcare systems have done relatively well. Small, advanced economies like Switzerland, Ireland, Norway, Finland, Singapore and Hong Kong stand out.
Country effect
From an investment point of view there may be a similar lesson. In times of market volatility and fiscal stress, the ‘country effect’ is often heightened as a driver of investment returns across bonds, currencies and equities.
This time it is likely to also be pronounced with investors favouring countries with steady finances, good institutions and reputations for innovation. From the point of view of the trend towards ESG – environment, social and governance – it means that the ‘G’ component will take on added importance.
This will be particularly the case in debt markets. As mentioned, the global economy is now gorged on debt, some of it backstopped by central banks, but a lot of it also close to default and in need of restructuring. Add to that the likelihood that new forms of debt, coronabonds possibly, will be issued and debt as an asset class will become very interesting, especially for investment banks, long/short credit funds and distressed debt funds.
Michael O’Sullivan is the author of ‘The Levelling – what’s next after globalisation’
