The pandemic’s long-term pain is just becoming clear to markets

By Christopher Anstey

The best month for global equities in almost a decade may be enough to convince investors the light at the end of the coronavirus tunnel isn’t a train, but the debate on what comes next is only just beginning as they adjust their focus to a financial landscape utterly changed by the pandemic.

An indisputable takeaway from the crisis is a massive expansion in global debt -- given the more than $8 trillion in fiscal measures worldwide, according to a Bloomberg compilation. Corporate balance sheets will have changed, as CFOs seek to bolster their capital through equity and debt raisings. Millions will have lost their jobs at least for a time, and labor mobility between nations may be impaired. And supply lines will be reshaped, at least in some fashion.

Depending on how it all shakes out, there will be implications for corporate earnings and interest rates that will affect investment decisions for years if not decades to come, some analysts are now saying. Should the epidemic continue to ebb, that’s set to become the key debate in markets as the year progresses.

“The high debt levels across all sectors and large-scale nationalization of the economy will, in absence of an exit plan, restrain investment and reduce productivity in the long run, giving rise to secular stagnation or at some point stagflation,” said Commerzbank AG strategist Christoph Rieger. “Corporates will have to shoulder a large part of the bill.”



Corporate Action
Even as they cheer news about economies reopening and progress on medical solutions for the coronavirus, investors are being diluted by corporate capital raising. And the biggest source of demand for shares in recent years -- companies themselves -- are unlikely to return to their previous pace of buybacks for years, if ever, according to Inigo Fraser-Jenkins and fellow analysts at Sanford C. Bernstein.

A deeper change could be sustained support for payments to portions of the labor force that have been severely affected by the crisis or at the fringes of economic prosperity in recent decades. As Stephen King, senior economic adviser at HSBC Holdings Plc, put it, there could be “pressure to deliver new domestic ‘social contracts,’” not unlike occurred after World War II -- when Europe built welfare systems and the U.S. enacted the GI Bill.

A new broad set of commitments “would be affordable only with a sizeable increase in the tax burden on corporations, high earners and the wealthy,” King wrote in an April 23 note. “To raise such taxes may require worldwide income-tax regimes for a country’s citizens (in line with existing U.S. tax policy) and significant restrictions on the mobility of wealth and capital.”

State Role
A stronger long-term role for the state is emerging in other aspects, as well. The long-term trend of privatizing public-sector enterprises “could now be slowed or even reversed,” Deutsche Bank AG wealth-management investment chiefs say.

“State ownership of industry will force a new debate on the role of competition and profit margins,” Christian Nolting and Markus Muller wrote in an April 29 note. “All this will create major challenges for economies and investors, but also opportunities.”

As for investors in government bonds, given how debt levels will have expanded versus GDP -- Commerzbank sees the U.S. government’s ratio hitting 100% next year, from about 80% pre-crisis -- it’s unlikely policy makers will let interest rates exceed inflation. So-called financial repression also helped major nations run down debt after WWII.

The surge in borrowing has also revived the debate about central banks directly monetizing government financing. At the end of the day, however, that simply swaps one type of obligation -- government bonds -- for another: reserves deposited with the central bank, as Commerzbank’s Rieger puts it.

“In the end, the asset side of central bank balance sheets will consist of giant quantities of low-yielding debt -- inhibiting rate increases for decades,” he wrote.

Creative Destruction
Net-net, lower borrowing costs ought to be good for companies, and equity valuations in particular. Stephen Jen, who runs hedge fund and advisory firm Eurizon SLJ Capital, argues it “ought to be a major tailwind” for strong firms with good balance sheets. But his take suggests not all will benefit -- something Deutsche Bank AG wealth-management investment chiefs agree with.

“Those sectors better able to innovate and adapt to the new post-coronavirus world will fare better; ‘creative destruction’ could force corporate failure and defaults elsewhere,” Nolting and Muller wrote. “Corporate earnings are likely to fall further than current consensus estimates.”

The bottom line: the debate on long-term effects for investors is just beginning.