Throughout the coronavirus crisis, Funds Europe presents some of the best market commentary from fund professionals. Today, George Lagarias, chief economist at Mazars, talks about “exponential effects”.
Albert Einstein once famously said that, “Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn't, pays it.” Exponential mathematics is about speed, which is why Coronavirus has overtaken healthcare systems so quickly. By extreme “social distancing”, the kind of which we have never seen in an organised manner globally, it took us about 90 days to reach a million confirmed cases, more than 4x the time it would take otherwise.
Unfortunately, the economic consequences of the pandemic are also exponential. A shop takes a few days to close down, and months to open up a new one. Someone who’s left unemployed, especially in a downturn market, might take years to reach their previous salary level, so spending will go down. Despite the massive and unprecedented amount of monetary and fiscal stimulus, we are quickly reaching a tipping point where the economic repercussions of social distancing, will become equally exponential, and permanent in a way that will require significantly more stimulus to balance.
The real danger is for recession - which is all but certain in 2020 - to turn into a depression. If one fears a repetition of an event, then one may not take the risk to open a business. In this scenario, governments finally have to take on the role they had happily bequeathed to central banks in the last decade, and underwrite risk in main street businesses, a model which would see the demise of Liberal Capitalism and the advent of China-like State Capitalism.
So, this is the conundrum: relaxing the measures, could risk a significant rise in mortalities, close to WWII levels by some counts. If we don’t relax the measures before a tipping point is reached, we risk our economic system, let alone our individual economic futures and possibly our liberties. The only good scenario is that we stall the virus long enough to find a cure, but not long enough to tip our economic system and consumer behaviour. Where that optimal point lies, is still hard to say.
Still, our analysis suggests that asset allocation still works. Stock and bond markets are comprised of the bigger companies. Large and listed companies with enough cash, which comprise most of our underlying equity assets, will probably continue to operate as always, despite the loss of earnings, as governments take on some of the business risk, through fiscal stimulus, while cash-strapped smaller competitors may go out of business. In a world where online shopping will probably become even more of a staple, big operators who have embraced it are already weathering the storm.
The true conversation is what happens to bonds. It will be very difficult to escape a zero-yield world in the next few years, which means probably a real negative yield for bond holders, who can only hope to make up the loss by having the central banks as a very strong buyer of the asset class. Be that as it may, it’s still a good reason to hold them as a diversifier in a portfolio.
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