Nils Bohr, the Danish physicist is rumoured to have stated ‘Prediction is very difficult, especially if it’s about the future!’. I agree.
Last March with the pandemic in full, terrible flight, I laid out three scenarios for how the coronavirus hit world and its financial markets might develop (https://thelevelling.blog/2020/03/28/why-did-nobody-notice-it/). To a certain extent, each of my optimistic, medium and pessimistic scenarios played out – such was the unpredictability of the virus and the ways in which it and other forces caused economies and political systems to contort themselves.
In particular, my prediction of a nasty, second wave was largely correct –
Under this ‘pessimistic’ (20%) scenario, much of the world’s workforce is disrupted by the virus, and second waves become the norm. Social unrest, political disunity and a breakdown in diplomacy between nations (US and China for instance) are some of the resulting side-effects. Monetary and fiscal policies cannot contain the full effects of bankruptcies and unemployment, to the extent that central banking ‘accidents’ crop up. The 1930’s is the nasty template to follow here. Property markets and alternative asset classes like private equity are hard hit
What is striking is the part I got wrong, that financial and market collapse was not the natural consequence of the second wave of COVID and the economic damage it has caused. That much is due to the speedy arrival of vaccines, generous fiscal packages and the seemingly never ending supply of central bank liquidity. This last factor is the one that has made the difference between an ebullient market environment and a cruel and testing real world.
In last March’s note I wrote that the distinguishing feature of the coronavirus’ passage through societies and economies was its speed, and this continues to be the case. Vaccines have been developed at a record pace, in many countries – the US for example – the economic rebound is speedy and the adjustment of businesses to a more digitally driven economy has been rapid.
With vaccination rates rising quickly in developed countries – Switzerland and France for instance are accelerating their programs – it is now time to take stock, and offer a few more predictions, or at least frame some broad scenarios.
As background, we know the following ‘truths’ in the light of the coronavirus crisis. Central banks continue to be the force that holds markets together and loftily above the reality of an at times wretched world. In coming weeks, the beginning of the debate on the Federal Reserve’s tapering strategy may induce more volatility.
Then, at a country level we do not yet know what kind of ‘model’ has best withstood the side-effects of the virus, though it is clear that populists (Modi, Trump, Bolsonaro for instance) struggle with the health, social and economic effects of the virus.
In addition, the rise of the digital economy and manifest changes to the way we work are increasingly well understood. What is altogether less welcome is the general lack of collaboration between nations (the spat between Britain and France over fishing rights near Jersey is another example of this), and the emergence of a steadfast geopolitical rivalry or ‘Great Game’ between the USA and China (and Russia), that increasingly incorporates a scramble for scarce resources (rare earths, computer chips, and the Arctic for example).
Looking ahead, pent up demand and hefty fiscal and monetary stimuli, together with the fact that different countries are exiting the coronavirus crisis at different times, and the background factor that the crisis begun at the end of one of the longest periods of expansion in economic history, makes forecasting the near future all the more difficult. Notwithstanding that I can think of three scenarios to bear in mind till the end of 2021.
‘Brave new World’ (30% probability)
The ‘Brave New World’ is one of extremes. In this scenario, the large economies have emerged from the coronavirus and growth is barrelling forward. Despite manifest inflation, central banks are slow to rein in activity. Investment in new technologies is booming – Europe leads in green technology, the USA has a 5G revolution and China is the quantum computing leader. Central banks introduce digital currencies faster than many think necessary, drones become the frontier military technology and a debate begins on a new world institution to police the internet. Climate change becomes a significant driver of security across Africa and Asia.
In finance, investors increasingly differentiate between ‘new’ industries and companies and ‘old’ ones, such that many long established banks, consumer brands and energy companies trade at record high dividend yields. At the margin, asset managers and large family offices build portfolios that include sizeable private asset portfolios (private debt and venture like investments), crypto currency and stablecoin portfolios, agriculture centric assets in Latin America.
High food price inflation slows growth in many emerging countries, and in the developed world, falling bond prices cause pension fund crises across Europe.
‘Two Armed Economist’ (45% probability)
This scenario is more probable, but less clear – if that makes sense. The reason for this is that once the initial ‘post-COVID’ bounce is over, we will enter a world where imbalances are met with market and policy responses, and overall economic and market outcomes will be volatile. For example, it is now clear that the Biden administration is reacting to wealth inequality in the way it is framing fiscal policy, and that in addition extreme price moves in eclectic assets – from Ethereum, semiconductor chips to lumber – are causing real world economic pain and confusion.
This pattern of ‘equilibrium’ building continues – in many countries economic activity becomes better distributed away from capital cities (Paris to Bordeaux, Dublin to Galway) and across regions (Amsterdam to Barcelona, Zurich to Nice?) such that there is a new wave of infrastructure spending on telecoms and public services, and property market growth follows a similar path. There is a slow but meaningful revolution in healthcare and education, and at the universities level, the multidisciplinary ‘complex systems’ approach is in vogue (again, following Nils Bohr’s example).
In markets, the lingering coronavirus (and inflation) slows growth in emerging markets, the trend towards the democratisation of risk continues and the apparent rise of inflation causes both the major asset classes, developed world equities and bonds, to underperform somewhat. The surprise is the ongoing failure of the dollar to rise, though printing presses may have something to do with that.
‘Reckoning’ (25% probability)
A reckoning scenario, where many of the risks that are building in the global system (climate damage and super high debt levels) begin to erupt, is in my view likely between now and 2024, but just not in 2021 (I sound like a two armed economist or a central banker!).
This scenario will most likely develop around the permanent effects of the coronavirus on the labour force, a macro environment characterised by stagflation, which in turn leads to widespread popular discontent as real wages fall. In such an environment, fiscal policy is effectively spent from the recent rounds of stimuli, and monetary policy is rendered ineffective by rising inflation and low growth. As such markets begin to price in the risks associated with very high debt levels and a credit crisis ensues. In this scenario credit and broad equity markets falls by up to 20%, with short-term government debt in developed world countries gaining. ‘Democratisation of finance’ type investments suffer a huge liquidity drawdown that produces a numbing ‘democratisation of risk’ retail investment crisis in the US and China.
This is a sobering scenario, but at least it may not play out just yet, not next week anyway.
Have a good week ahead, Mike
The Levelling 