A number of commentators since the 2008 Great Financial Crisis have expounded the notion of a ‘New Normal’ which seeks to explain the recent evolution of financial markets and the real economy.
The ‘New Normal’ has meant several things, including a world with lower interest rates, slower economic growth, higher government regulation and lower discretionary spending. The term is re-emerging with popularity amid the spread of COVID-19, a black swan event, as commentators imagine a post-pandemic world.
While we imagine what awaits the world economy, financial markets, too, are adjusting to an uncertain world where current market volatility is symptomatic of divergent market participant views, exacerbated by margin calls, forced liquidations, and automated trading algorithms attempting to navigate the new rules of engagement through relying on yesterday’s patterns and data.
While market volatility will likely persist until there is more clarity on the new world order, central banks and governments have appropriately intervened worldwide to ease liquidity and credit conditions for households, businesses and regional governments; their goal is to curb unemployment and support a world economy that grapples with a sudden stop, which has caused millions of people to lose their jobs in just weeks.
Following steep declines in March, equity markets have risen in response to trillions of dollars of stimulus measures announced by governments and central banks, some of which are unprecedented. For example, the US Federal Reserve announced a new US$2.3 trillion package in April which would include purchases of investment grade and high-yield debt of US companies that were rated triple B as of 22 March. While supporting companies, now rated junk, could proliferate the number of ‘zombie companies’, similar to what has occurred in China and Japan, the move is necessary in the short term to protect jobs and prevent negative feedback loops in the financial markets and real economy.
Absent a miracle cure or rapidly developed vaccine for COVID-19, however, it is unfortunately unlikely that we will see a V-shaped economic recovery in which those who abruptly lost their jobs will be quickly rehired and economies will spring back to life. More likely, it will take time for economies to open up, potentially with rolling lockdowns as new waves of the virus emerge.
Meanwhile, households and businesses will be busy repairing their balance sheets, while consumers will be seeking confidence to once again interact with others. During the lockdowns, many consumers will also have had time to reflect on and reprioritise what matters, and several habits may change, benefitting some business models while negatively impacting others.
This emerging reality will create pockets of investment opportunities where thoughtful investment selection and active investment management will offer scope to generate outsized returns. For example, whereas I argued in my January Market Watch article, ‘Lessons for investors from world’s leading pension funds’, that US investment grade corporate bonds were overvalued at the time, the asset class offered pockets of significant value a few weeks later due to the indiscriminate selling of corporate bonds. We were able to capitalise on this opportunity by selling US treasuries and buying highly rated US investment grade bonds trading at discounts to US treasuries not seen since the Great Financial Crisis.
At the time of writing, opportunities to generate reasonable returns continue to exist in US investment grade and selected high-yield bonds with continued purchases from the Federal Reserve offering support. Indeed, as company dividends start to disappear as earnings disappoint and balance sheets weaken, investors seeking yield will likely turn to investment grade corporate debt as sources of income.
Nassim Taleb, author of the books ‘The Black Swan’ and ‘Antifragile’, argues in the latter that stressors, provided they do not overcome us, can help individuals, as well as businesses and systems, become stronger if they continuously adapt. Likening the pain felt during workouts leading to stronger muscles, the challenges faced by world economies due to COVID-19 can lead to more resilient systems and improved businesses provided that households, businesses, governments and institutions can rise to the occasion.
Actively investing in anti-fragile businesses, institutions and countries can yield strong investment returns over the longer term. To the extent that households, businesses, institutions and governments seek to be anti-fragile in how they operate, it is possible for the world economy to emerge stronger and more resilient.
In thinking about investment opportunities in our emerging reality, it is instructive to think about economic prospects not in terms of a ‘New Normal’, which has often had negative connotations, but rather a ‘Better Normal’.
In the ‘Better Normal’, governments and investors can play an active role in supporting a world economy which becomes more resilient to future shocks, and moves away from a model of unfettered capitalism, which has exacerbated challenges emanating from the current pandemic. To be clear, if all workers in the US received paid sick leave, for example, they could have stayed at home when feeling sick rather than forcing themselves to go to work to help make ends meet.
Indeed, governments worldwide are taking a hard look at existing and new policy approaches, including those related to universal basic income, healthcare funding, and other ways to stem economic inequality, which has undermined efforts to contain the current pandemic.
To help build the ‘Better Normal’, investors can choose to actively support governments, businesses and institutions that are working toward fostering a more inclusive form of capitalism. We have seen over the last few months individuals, companies, governments and institutions come together in ways that we could not have imagined before. We have the makings of a ‘Better Normal’ in front of our very eyes.
Zafrin Nurmohamed is a senior portfolio manager, asset management, at Butterfield.
Sources: PIMCO, Financial Times, Antifragile by Nassim Nicholas Taleb, US Federal Reserve