As the Covid-19 crisis has unfolded, one of the key themes emerging is the ‘tug of war’ that has developed between inflationary and deflationary forces. On the deflationary side, the massive collapse in private sector-generated cash flow and incomes since the introduction of lockdowns is likely to result in significant deleveraging as business and household appetite for debt declines with increased perceptions of economic uncertainty/risk. Conversely, the unprecedented policy response, with public-sector balance sheets expanding to new levels in an attempt to limit the fallout from the crisis, represents an inflationary influence.
Based on financial-market price action since late March, it would be tempting to conclude that the reflationary forces are winning. However, although economies appear to be regaining some momentum as restrictions on economic and social life are eased, until a vaccine is found for the virus there will be restrictions and costs related to doing business that did not exist before. Furthermore, the risk remains that a resurgence of the virus could overwhelm health-care systems and cause additional economic damage.
Investors face a variety of other challenges including the forthcoming US presidential election, rising tensions between China and the US, and the ‘fiscal cliff’ likely to be created if US Congress ultimately fails to pass a new stimulus bill. The growth outlook will also be influenced by a number of structural factors, including the worsening global debt burden, and an accelerating trend towards digitalisation.
Against this distorted backdrop, volatility looks set to continue to be a feature of financial markets over the coming months. This can unearth compelling opportunities for long-term investors able to focus on the securities of companies with the qualities that will help them survive the crisis and emerge stronger. These include resilient earnings streams, robust balance sheets, and sustainable business models.
Brendan Mulhern, global strategist, Real Return team, Newton Investment Management.