April 23, 2020
What the world looks like when the crisis ends is truly anyone’s guess, but I will say with 100-per-cent clarity that it is going to look a lot different than it did before. Months of isolation and distancing and fear of a return of the pandemic are going to fundamentally alter lifestyles and will have a profound influence not just on the way we live but how we conduct ourselves in our business and commercial lives.
Working from home is certainly going to be a more dominant force, with obvious negative implications for commercial real estate, but positive implications for internet infrastructure, computer hardware and video conferencing. There is going to be a sharp reduction in travel to work, indeed travel in general, and this means fewer cars on the road. All the reasons to avoid the energy sector will now be accentuated, and there’s nothing good here for the auto sector or office real estate investment trusts.
Delivery services, on the other hand, have now become an essential, so here is a budding bull market right there for Amazon.com and any business model that copies it. I should tack on grocery chains with online services coming out of this as a winner. I sense that spending on robotics, which was already very strong, is now going to go parabolic. It goes without saying that biotech and pharma will be sectors you want exposure to for a long time. The one thing that came out of this is the realization that the U.S. health care system is way too overregulated, so political risk will largely disappear from this group.
But from a really big picture standpoint, we also come out of this with a world that is going to be smaller; a world that is more nationalistic, much more protectionist than before. So globalization and just-in-time inventories stall here because we have seen, in real time, the importance of having stockpiles on hand. With reduced global supply chains, get ready for higher inventory financing for every unit of production.
This tells me that the global corporate cost curve goes up in a secular fashion, at a time when we will still be operating with an output gap for an extended duration, which in turn means more compressed profit margins, and all at a time when share buybacks will be slowed in favour of retention of cash on business balance sheets. It has to be understood that the share buyback craze, funded by the most profound debt-for-equity swap of all time, alone added 1,000 rally points to the S&P 500 this past cycle. This was the most pronounced source of demand for equities in the bull market, and now it is going to play a more minor role.
We also have to add to this mix the fact that even if half of the bear market gets reversed, the household sector in the United States just got hit with a huge negative wealth shock, and this happens with the median age of the dominant baby boomer at 65 years, not 53 as was the case in the great financial crisis, or 45 during the tech wreck. In the United States alone, we are talking about more than 70 million boomers who are going to be forced to reassess their calculations of what their retirement lifestyle is going to look like, or if they can retire at all.
This speaks to the likelihood of a prolonged period of a rising personal savings rate, which, by the way, recalibrates to a much lower GDP growth rate in the future. If the past decade was the weakest economic cycle on record at 2-per-cent growth a year, then 1 per cent in the future may be the new norm, which in turn means stagnant in real per capita terms. That, as a result, sets us up for a new and lower estimate of the fair value price-to-earnings multiple in the stock market, a much higher general level of risk premia and why I think we will be heading into an elongated period where, to be successful, you’ll have to pick securities or sectors instead of simply markets or major averages. So I sense the exchange-traded fund industry will have to undergo some adjustments as well.
As for interest rates, I want to point in your direction a report that the Federal Reserve Bank of San Francisco published last month on the past 15 great pandemics since the 15th century. It concluded that we go through years in which private savings trend up and investment trends down, and that leads to a semi-permanent decline in the natural rate of interest, on average by 150 basis points, which is a little unnerving since we started this cycle below 1 per cent to 1.5 per cent on the neutral rate. So we are destined now to be right at the floor for interest rates both of short- and long-term maturity for an extended period of time.
And even if inflation comes back, the Fed is going to cap yields, as is done in Japan. (The Federal Reserve Bank of New York just wrote a report, too, on how the Fed targeted long-term yields from 1942 to 1951.) I have to say, the prospect of ever-negative real yields tells me that the one exposure you do want in your personal accounts is gold, which, amazingly, is still 13 per cent below the all-time high it set on Sept. 6, 2011.
David Rosenberg is founder of independent research firm Rosenberg Research and Associates Inc.
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