A year before the current pandemic, we had set out at Schroders a set of trends - compelling truths - that investors would face in the next decade. Today, we believe that Covid-19 is accentuating these trends, with new challenges for growth, more pressure on public finances and inequalities, a faster increase in technological transformation and a growing populist threat.
If it is certain that the pandemic is already affecting the behavior of people and companies, shaping the medium-term perspectives for economies and markets, in the face of these compelling truths, investors will also have to be even more agile to achieve their goals.
1: low interest rates
In the context of a health crisis, which is also an economic crisis, both with a profile to continue, the behavior of people and companies is changing the previous relationship between savings and consumption and investment. Now more aware of the vulnerability of their income, families and companies are more concerned with building some reserves that make them feel safe and less willing to consume or invest.
The first consequence of this combination of higher savings rates and lower investment is slower growth, as this weakening investment makes it difficult to recover activity and productivity, resulting in slower GDP growth.With interest rates so low in the pre-pandemic phase, there will now be no pressure or latitude for them to rise, and should remain low in real terms for a long period.
2: health care expenses rising
Average health expenditure, as a percentage of GDP, has been increasing in the OECD due to an aging population and the situation is now accentuated by Covid-19, which presses governments to invest in the capacity and resilience of public health systems.
In the USA, health spending has increased from 13% to 17% of GDP since 2000, the highest level in the OECD, and in Europe, it represents 11% of GDP, a percentage that has grown significantly in the last 20 years. Increasing these expenditures even further is a major challenge for public finances and the IMF expects the public debt of the G20 countries to rise to 150% of GDP by the end of 2021.Governments will thus face the unpleasant decision to raise taxes or cut public spending to contain budget deficits. It seems more likely that they will choose the financial route, keeping interest rates below the nominal GDP growth rate to improve the debt-to-income ratio.
3: Populism growing
Across the world, the prevailing economic orthodoxy has been challenged by populist movements, which choose to reduce debt through inflation rather than austerity.
Populism, one of the disruptive forces that we considered in our compelling truths, means, in this context, that governments move away from the still prevailing political and economic guidelines - namely in the inflation targets - to adopt policies that allow, for example, the impression of money to be applied directly to the economy.
The result would be higher inflation which, if taken far enough, could give rise to hyperinflation. Debt-to-GDP ratios would improve, but as those who remember the 1970s will know, these policies do not make governments properly popular: higher inflation destroys the real value of savings, reforms and pensions and given ( increasing share) of the senior electorate, this is an electoral liability that no government will be interested in dealing with.
4: technological transformation to accelerate
In a scenario more conducive to populism, real wage growth is expected to remain weak and income inequality tends to widen further. This gap may be driven by post-crisis technological acceleration.
On the one hand, we know that "necessity sharpens ingenuity" and, as we have seen, confinement has already "sharpened" online sales and all aspects of remote work. Urban retail has suffered and offices may be next, now that companies have been transformed to make distance work possible.
On the other hand, Covid-19's experience is leading many companies to rethink their supply chains. Travel restrictions and the need to make these chains more resilient dictated the need to expand the range of suppliers and, in some cases, to seek that supplies and production are closer to home, which in the long run will be yet another blow in globalization.
This relocation implies more unemployment in emerging markets and more automation in developed markets, where higher labor costs tend to prevent an increase in hiring. Artificial intelligence (AI) and robotics are likely to be two of the areas that will accelerate.
In the long run, this technological acceleration is expected to contribute to increased productivity, firstly due to reductions in travel and large offices. However, in the immediate future, it also causes the destruction of jobs and companies in developed markets, in sectors such as air transport, travel agencies or corporate property managers. In the same way, it generates redundancy of functions, with the need to requalify many workers and the unsuitability of others, which will increase public dissatisfaction and the search for populist solutions.
Director of institutional clients and the Portuguese market Schroders
Source: BCP Millennium Schroders