The coronavirus has highlighted a reality: how dependent financial markets are on monetary and fiscal authorities.
It has been two years since the Covid-19 pandemic. The worst health crisis the planet has experienced in this century, which has left behind almost six million deaths and more than 500 million people infected. On March 11, 2020, the World Health Organization (WHO) declared the coronavirus a pandemic, marking a turning point in our lives. Three days later, on March 14, the State of Alarm was declared in Spain and with it the general confinement of the entire population.
Beyond the personal impact the pandemic has left on each of us, investors had to cope with sharp declines in the markets during the first few weeks. If the coronavirus has made one thing clear, it is that investors need to be more prepared for future black swans. So we wanted to find out what investment lessons asset management industry professionals have learned from the past two years.
Two years of pandemic: what have we learned?
Francisco Quintana, ING Investment Strategy Director
The pandemic has taught us four major investment lessons.
First, we have realized that time and energy must always be devoted to extreme risk analysis. Pandemic is not a "black swan" (we have had many in the past and could have taken preventive measures) but it is a low-probability, high-impact event. There are many other similar examples-cyber attack, power outage, satellite communications disruption from a solar storm, chemical attack-and while investing with the sole priority of protecting against these potential events is unreasonable, an investor should design his or her portfolio with them in mind.
A second learning has to do with the old strategies - they seem to work. Diversification is still the best tool for navigating an uncertain world. And low cost, and the cold blood not to lose money trying to guess market gyrations. But of all these techniques, diversification remains the most powerful. Assets that can lose their appeal over many years-bonds, gold, oil-justify their presence in the portfolios of conservative investors in such periods, and those who ignore them often regret it.
In addition, we have seen how in periods of crisis, behavioral economics is an even more valuable investment tool. Under stress, some irrational reactions are amplified. For example, the topicality bias, which gives more weight to recent observations when modeling the future. In April 2020 many were investing as if normalcy would never return. Contributing for the energy, hospitality, travel or restaurant sectors seemed crazy. Investing at the height of fear in those sectors would have been a great deal. Energy led the gains in 2021 and a few days ago the profitability-since the start of the pandemic-of the Hilton hotel chain surpassed that of online meeting software Zoom.
And finally, a very valuable lesson: no one has made money betting against central banks in the last fifteen years. If the Fed or the European Central Bank announces its intention to support a certain asset, bet on that asset. Tie your money to that of the central bank because nothing seems to be able to derail them. They have always been relevant institutions, but never as decisive as in this period of history. In the future this may not be the case, but for the moment, it is indisputable.
David Ardura, Chief Investment Officer, Finaccess Value
Beyond the undeniable personal impact that the pandemic has had on society as a whole, these two years of Covid have left us with a number of lessons for the investment world. The main one has to do with the market's reaction to unexpected events. We are used to managers, analysts and strategists presenting, usually at the end of the year, the risks that can change the market's roadmap. The problem comes when we realize that if all those risks are there, written on paper, the market has already incorporated them to some extent in its prices.
As happened in the great financial crisis, the possibility of a pandemic did not appear in any of the forecasts. It belonged to that world of black swans which, unfortunately, have been more common than desirable in recent years. It should therefore come as no surprise that it had such a devastating effect on the market, both in terms of the amount of the falls and, especially, their speed. The latter is another lesson to be learned, how quickly the market can move in the face of a risk event. Unlike other situations of market falls, more prolonged in time, the fall in the pandemic left investors unable to react, so trying to anticipate the market once again proved to be inefficient (remember that the violence and speed of the rebound was proportional to that of the falls).
The pandemic also revealed a painful reality that is the subject of debate these days: how dependent financial markets are on monetary and fiscal authorities. Going back to the end of March 2020, there was no solution other than a coordinated action of fiscal and monetary policies. This saved the market and led to a market recovery. However, like any strong medicine, it is not easy to take it away from the sick and the side effects are significant.
We are now discussing inflation (speaking of unexpected events) and the withdrawal of stimulus and rate hikes that threaten economic recovery. It remains to be seen, especially in Europe, whether the market and the economy can live with this without sending us back into recession.
One of the benefits of history is that it is there for us to learn from, but we may once again think that we are capable of anticipating the future, that everything can be modeled and controlled and that tail events deserve to be disregarded. Assuming that none of this is possible, the investor's best ally will continue to be to look at the long term, invest with common sense and think that crises always bring with them great opportunities.
Thomas Hempell, Head of Macro and Market Analysis, Generali Investments
It is hard to sound exaggerated when speaking of the historic dimensions of this pandemic, an event that has cost nearly six million lives and infected more than 400 million people so far. It has led to the deepest global recession since World War II, one of the strongest recoveries and a profound change in work patterns and workplaces, social interactions and economic relationships. From an investor's point of view, three lessons stand out.
First, Covid is a reminder that investors should be prepared to consider more frequent black swans in their long-term return expectations and risk management. In an interconnected world, international supply chains and global travel allow disruptions (from disease, geopolitical tensions, etc.) to become global problems more quickly. This is especially true in the case of climate change, which increases the risk of natural disasters with broader implications for migration and geopolitics. In addition, the tight network of global systems and software increases global cyber vulnerabilities.
Second, crises are opportunities for contrarian investors if the deep pockets of governments and central banks are on their side. Unlike the Great Financial Crisis of 2008/2009 and the European debt crisis, governments and central banks acted quickly and boldly during the Covid. This has helped the global economy to recover much faster even at the cost of rising government debt. Global equities have nearly doubled from their March 2020 lows, thanks to the profits of contrarians who bought during the sell-off.
Third, the supply side is important. In the wake of global shocks, investors and economists need to better appreciate changes in the economy's productive capacity and their implications for assets. Inflation, for example, will remain elevated on a more durable basis in the postcool world. Climate change increases price risks, due to costs arising from a higher incidence of natural catastrophes and mitigation policies. A structural revival of inflation also means the end of the three-decade era of low and diminishing returns.
Johanna Kyrklund, Global Head of Multi-Asset Investments at Schroders
Despite the few glimmers of normalcy we have as Covid infection rates decline, the current crisis is far from over. Moreover, the pandemic forced governments to put stabilizers on the economy to curb cyclical volatility. But now, those stabilizers will disappear and the private sector will have to pick up the baton of growth.
This scenario shows us that we are facing a changing world. Thus, if in the last 25 years we have focused on the interest rate cycle, in the future, pricing, carbon regulation and the increasing adoption of sustainable energy sources will be just as fundamental to market behavior.
According to our analysis, we are now entering a more mature phase of the economic cycle, as growth momentum peaks and central banks begin to withdraw their support. We expect equity returns to be more subdued but still positive, supported by strong corporate earnings.
Inflation is a recurring theme, and we agree that in the medium term we are likely to find ourselves in a more inflationary environment compared to the last decade. This is driven by rising wages, de-globalization and decarbonization. In the shorter term, we expect inflationary momentum to peak as supply bottlenecks ease, although central banks will continue to raise rates.
At the stock market level, it will be important to identify companies with pricing power, given the risk to margins posed by rising input costs and wages, as these companies will be better placed to weather the storm. As for the debt market, the willingness of central banks to start raising rates in response to inflationary pressures should help mitigate any sell-off in the long end of government bond yield curves.
The one area that might surprise is China, where, unlike other major economies, policy is turning bullish.
All in all, we can conclude that this pandemic has shown us that times change, opportunities persist, but the ability to be flexible and agile will be key. In simpler terms, diversify risk: this is not the time to make big bets.