It’s Not the Beginning of the End; It’s the End of the Beginning

September 2020 – 3 min read
As investors look past the pandemic, the weak cycle coming into view means the best returns depend on identifying secular change.

Market tremors last week sent chills while they lasted, even if most investors took them in stride with volatility actually falling and most market commentary shrugging them off as an overdue “correction.”

But if you’re trying to put money to work as this brutal year comes to a close, you have to answer a few key questions:

  1. Is COVID-19 over? (Yes)
  2. Will next year be “normal”? (Yes)
  3. What’s the best way to play the next cycle? (Ignore the cycle!)

First, if it seems blindly optimistic to pronounce the pandemic over, the data that drives investment decisions continues to improve. Chinese industrial production is now 4% above last year’s. Europe’s purchasing manager indices signal expansion. Headline U.S. unemployment continues to edge lower.

COVID-19 cases are still rising in some parts of the U.S. and Europe, and trends remain worrying in places like India and Brazil, but the world has learned to live with the risks. Death rates are mostly falling, treatments are improving and by next year we are likely to have a short menu of alternative vaccines. Even the United Kingdom’s fresh measures to limit gatherings to six people do not come with business restrictions. As global curves flatten, “coronavirus” will soon fall from the list of investors’ “Top Ten” fears altogether.

Global New COVID-19 Cases (per million, 7-day rolling average)

Source: Bloomberg. As of September 11, 2020.

All this means that next year will represent a return to a “normal” global economy that depends on standard measures of GDP growth, unemployment and investment. These numbers will look good on paper as they bounce off 2020 lows. But they will feel a lot worse in practice as they blend the slow trajectory of the global economy over the last decade with the lingering scars of the crisis itself.

The final healing of the U.S. labor market now looks painful and slow given the rising numbers of long-term unemployed and those who have left the workforce altogether. Business bankruptcies have actually fallen in Europe, but that is hardly sustainable once government support starts to ebb. Retailers may struggle through to the end of the year in a last gasp of profitability over the Christmas holiday, but January will bring a fresh reckoning and a new round of closures.


Source: Haver and Bloomberg. As of September 8, 2020.

And this is what makes the next cycle so tricky for investors.  It looks just like the old cycle, but even more so: even slower growth, even lower inflation, even more debt. On average, most developed countries will have added debts equal to at least 20% of GDP.

To be sure, there’s a scenario in which the massive injection of fiscal and monetary support leads to a brief surge of rising prices, but the large excess capacity in the economy means it won’t last long. There’s another scenario in which demand is so weak that even the best efforts of the world’s central banks can’t turn back the deflationary forces from technology that hollows out the labor market and inequality that undercuts demand.


Source: Factset. As of September 11, 2020.

But with central banks committed to easy money and governments happy to ignore budget deficits for now, the recovery looks well supported. An investor’s task must be to find opportunity in a world of feeble demand and stable prices. Since the cycle won’t really help much, the best returns will go to those who can navigate the secular trends that the pandemic may have accelerated.

“An investor’s task must be to find opportunity in a world of feeble demand and stable prices. Since the cycle won’t really help much, the best returns will go to those who can navigate the secular trends that the pandemic may have accelerated.”

Above all, this means the rapid introduction of technology, and especially artificial intelligence, that shatters a generation of business practices and has already begun to refashion everything from manufacturing to health care to education. It means a rising concern for climate change that will boost demand for more clean alternatives and curtail less-essential travel. It means new patterns of living, working and shopping that transform returns on real estate.

These are opportunities that require bespoke analysis, intuition and a little luck. In many cases, they also require access to private markets where money has been flowing in abundance.

Market pundits wring their hands over the dominance of a few technology stocks in the recent run, and value stocks may well catch up at some point. But the lofty tech valuations are also a signal that structural economic change will deliver more profits than simply awaiting the return of a lackluster post-pandemic normal.

With apologies to both Winston Churchill and Black Sabbath (who were speaking to very different audiences), investors should not view the latest market turmoil as the beginning of the end of a breathtaking rally, but rather as the end of the beginning of a new muted cycle that will require a sharp focus on secular change.

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