We think the three big questions facing investors over coming months are likely to be:
The greater impact is likely to come from government responses to the crisis. Unemployment and a massive build-up of debt are likely to be two enduring legacies of 2020. We expect this to result in a multi-year extension of enhanced monetary stimulus (cheap money) and massive infrastructure investment, specifically directed towards the green economy. Corporates may well be expected to help balance the books, especially unpopular ‘polluters’ and the much-politicised consumer tech companies.
The more important question is whether interest rates will rise and what will be the implications if they do? We make no predictions but offer the following observations.
- Rising unemployment and excess capacity in global economies are likely to limit the effectiveness of central banks’ ability to reinvigorate inflation.
- The cost of debt will need to be kept low if governments are going to be able to service their rapidly growing debt piles.
- A rising rate environment likely indicates better economic activity and inflation, and while this may be good for broad corporate pricing, undifferentiated products will continue to be forced to compete on price and will struggle to deliver attractive margins. Disruptive forces will continue to disrupt, and zombie businesses will potentially be allowed to die.
Although the majority of the companies we invest in sell their products and services outside their home turf, we expect most to be relatively protected from near term political interference. Most importantly, we believe that these companies’ products are differentiated and highly valued by their customers. In addition, international revenues are to a large extent generated or manufactured domestically. In the cases where supply chains need to be brought increasingly onshore, we think it best to be aligned with companies that have the pricing power to pass on any subsequent cost inflation.
2 The yield of any investment has to be compared with the yield available from an investment of no or negligible risk, for which the 10 year government bond yield is commonly used. If the yield goes up, so should the expected return on riskier assets i.e. the P/E should fall. The same is true in reverse.
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