And why bonds and stocks may not be pricing in such different outcomes.
The headlines look confusing, the virus remains a mystery and earnings reports have abandoned all future guidance, but elements of the next global economy are already coming into focus and they may help explain the apparent contradiction between jittery bond investors and their more sanguine counterparts in stocks.
The early ‘20s will deliver even less growth and even more technology than the late teens, which will likely keep inflation at bay. There will also be more inequality and angrier politics, which will likely underpin a lot more government spending.
It may be nasty, brutish and long, but it will be a recovery.
The sporadic and differentiated reopenings around the world will bring relief to some, dread to others and a little of both to the rest of us who are lucky enough to still have workplaces awaiting our return. The path to “normal” looks worrying because fresh spikes in COVID-19 seem likely to delay or reverse the process in some places, even if another undifferentiated global–or even national–lockdown looks unlikely.
Recall that growth prospects weren’t all that great going into this crisis, even after the longest U.S. recovery on record. The secular headwinds from demographics, globalization and technology were hotly debated, but the record was clear.
Now we emerge with these same headwinds and a world of flagging confidence and battered balance sheets. Corporate debts have risen and household spending has collapsed. Construction already underway may be completed, but fresh projects will be postponed. Famously profligate American consumers are hoarding cash against an uncertain future, meaning new cars and splashy vacations will go on hold.
For some industries, the damage will be permanent. Restaurant operators in one survey give themselves a 30% chance of survival if the crisis lasts more than four months. Having forced a test of remote operations, many firms already envision a world with smaller office footprints and less business travel.
If this is the low-growth, low-inflation future that the bond market envisions, stock investors take comfort in the steadfast commitment of governments and central banks to underwrite the recovery, as uneven and grinding as it might be.
The massive interventions we have seen from governments and central banks around the world may slow, but they look unlikely to stop. Nancy Pelosi’s $3 trillion proposal looks more like a political ploy, but there is surely a bipartisan Congressional majority backing additional money. In Europe, Japan and China, governments are still focused on supporting recovery. Without a whiff of inflation in the air, central banks are too.
Moreover, as politics turn more populist in many democracies, new candidates arguing for fiscal restraint don’t seem to stand much of a chance. With most manual labor difficult to conduct amid social distancing measures, poor and working-class families have been disproportionately hurt by the lockdown. They seem likely to emerge demanding even more support from their governments and showing even less concern for the long-term fiscal consequences.
“If this is the low-growth, low-inflation future that the bond market envisions, stock investors take comfort in the steadfast commitment of governments and central banks to underwrite the recovery, as uneven and grinding as it might be.”
Finally, the technology that is squeezing costs and helping keep inflation in check may also drive attractive returns where firms understand how to adapt. Whether in mining or finance or manufacturing, managers who incorporate the potential gains from cloud storage or artificial intelligence into their business models can pay off their coronavirus debts and likely earn handsome profits. The laggards will probably sink.
With low government yields everywhere, investors can even justify some of the steep price-to-earnings multiples that have raised so many eyebrows. Of course, there will still be unexpected downgrades and surprise bankruptcies. Even if some markets look overly optimistic about the grim recovery ahead, next quarter will likely be better than this quarter, and next year will likely be better than this year.
Naturally, this modest trajectory faces risks. A mutation in the virus that accelerates its contagion might trigger another much broader shutdown. Angry politics that turn decisively against globalization could require supply chains to realign much closer to home, leading to price spikes, inflation and the end of central bank support.
For now, however, the months ahead will look a lot like the scene in the 1951 classic The African Queen, when Humphrey Bogart understands that further progress down river requires him to climb overboard and haul his boat through overgrown, muddy waters infested with detested leeches. The progress is slow and grim, but open waters ultimately lie ahead.