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Investment report: chasing yields in a new world

Expect a larger role for the state and plan accordingly
June 9, 2020

The coronavirus crisis will leave no one untouched by the time it’s contained. Hundreds of thousands will have lost their lives and hundreds of millions will have lost their jobs. There will be long-term macroeconomic and investment implications once we begin to recover. Most of these trends were already under way, but will be accelerated by the crisis. 

When the recovery takes hold, nationalism and protectionism will remain firmly in place. Before the virus hit, the United States had already imposed tariffs on China, but the current crisis has pushed other countries to adopt go-it-alone strategies as well. France, Germany, South Korea, Brazil, India, Turkey, Russia and dozens of others restricted exports of medical supplies, pharmaceuticals and food. It is in this context that the United Kingdom hopes to strike a trade deal with the European Union before it leaves the transition at the end of the year, as well as agreements with others to ensure post-Brexit growth is not entirely dependent on Europe. 

Investors should focus on identifying companies that may become, in essence, new “national champions,” which will benefit from state assistance to move production—and revenue—back to their home countries. 

The UK and US, for example, are now talking about new industrial policies, when state intervention has been taboo for years. These could involve tax incentives to encourage development of certain industries and the return of manufacturing firms, particularly in critical global supply chains. This is especially true for aerospace, defence and high technology. Biotech and pharmaceutical companies may get additional government support to develop and produce life-saving drugs. 

This is far from the only area in which we should expect to see change. Coronavirus could accelerate income inequality within developed countries. The workers hit most immediately by the lockdowns were hourly waged service workers in restaurants, bars, hotels and shops, who had already suffered from very weak wage growth over the last decade. A trend towards bigger, better-capitalised companies may accelerate, presenting workers with fewer employment opportunities and limiting their ability to negotiate higher wages. Rising income inequality will likely exacerbate the savings glut that has kept interest rates, inflation and growth low over the past decade. Higher market concentration will create winners and losers in technology, healthcare and retail. 

We will also have to learn to live with previously unimaginable levels of government debt. Borrowing to prevent a depression now may weigh on growth ahead as less capital is available to finance investment. Major central banks have made it clear that interest rates will be very low for the foreseeable future. 

To find yield, investors will have to move out along the risk curve and buy lower-rated debt. Governments are likely to pay for the crisis response with higher taxes. Given the precarious state of personal finances in the UK and the US, those governments are more likely to raise corporate taxes, which lowers investment, productivity, potential growth and therefore corporate earnings.

A larger role for the state in our lives may not be all bad. Many workers today are grateful for the legacies of past crises: The NHS in the UK was created after world wars, and social security in the US emerged from the Great Depression. These new social programmes protected the most vulnerable and created new opportunities for investors. Now, as then, the trick is being able to adapt to the new rules of the game.