The Impact of COVID-19: How Should You Invest?
By: The Finance Brief
Tags: Investing, Politics, Business, Covid-19, Finance

Image From The New York Times

A Post-Pandemic World

Since the start of COVID-19, governments around the world have been engaged in strict mitigation measures to curb the spread of disease. We have all experienced social distancing and lockdowns. And many of us have spent the past year worried for our loved ones and uncertain about the future. What is the impact? How will the economy look like? And how should you invest your money to find stability in a crisis?

Expect Low Growth for the Next Few Years

Even with the unprecedented monetary and fiscal responses from governments worldwide, the IMF projects a deep recession in 2020. In the near term, global growth is projected at -4.4 percent in 2020 and 5.2 percent in 2021. After the rebound in 2021, growth is also expected to slow to 3.5 percent in the medium term, implying limited progress toward catching up to forecasts prior to the pandemic. This is corroborated by the analysts at S&P 500 global ratings who project similar numbers though they are slightly more bullish in the medium term.

IMF World Economic Outlook: Impact on GDP forecasts

S&P 500 Global Ratings: Impact on GDP forecasts

IMF World Economic Outlook: comparing pre COVID-19 projections to present day

What Are the Assumptions in the Forecasts?

1. A Vaccine Bailout

Our reading of expert medical opinion is that a vaccine could be available and distributed around mid-2021, which we currently incorporate into our baseline. Multiple clinical trials are underway, and the medical consensus is that we could have one or more vaccines approved by the end of 2020. Those vaccines would then need to be distributed and administered, both of which are potential complications. In terms of the economic impact, a vaccine would greatly diminish the restrictions on activity and eliminate a key source of uncertainty hanging over consumption and investment. IMF World Economic Outlook: A Long and Difficult Ascent

2. Scarring Resulting in Supply Shocks

Since the onset COVID-19, governments and public health authorities implemented mitigation measures such as social distancing. This has resulted in shutdowns of entire sectors of the economy causing bankruptcies across industries especially in airlines and hotels. It remains to be seen whether this will entail the redeployment of resources away from sectors where activity will be constrained by distance.

3. Fiscal Stimulus and Policy Support

A total of 6 trillion direct tax and spending measures announced and implemented worldwide has maintained disposable income for households and projected cash flows. Moreover, central banks around the world have been fast to conduct quantitative easing by buying government bonds. This coupled with the lowering of the Fed Funds Rate to 0.25% has injected much needed liquidity into the financial markets and prevented a recurrence of the financial catastrophe in 2008–2009.

Expect High Uncertainty

However, given the nature of the pandemic and the subsequent global fallout, expect high uncertainty while governments and central banks navigate the increasingly complex environment.

The uncertainty surrounding the baseline projection is unusually large. The forecast rests on public health and economic factors that are inherently difficult to predict. A first layer relates to the path of the pandemic, the needed public health response, and the associated domestic activity disruptions, most notably for contact-intensive sectors. Another source of uncertainty is the extent of global spillovers from soft demand, weaker tourism, and lower remittances. A third set of factors comprises financial market sentiment and its implications for global capital flows. IMF World Economic Outlook: A Long and Difficult Ascent

Expect Low Inflation

Even with huge government stimulus and loose monetary policy from central banks, demand has still been low given the inherent uncertainty in the crisis. While interest rates are low, companies are still less willing to take on debt as it would place them under unnecessary risks. Thus, the effects of weak aggregate demand have outweighed the impact of supply interruptions, resulting in low inflation. Similarly, the market forecasts low inflation in the medium term as seen by the Five-Year, Five-Year Inflation Swaps.

IMF World Economic Outlook: Impact on Inflation Levels

IMF World Economic Outlook: 5-Year, 5-Year Inflation Swaps (indication of the market’s projection of future inflation)

What Could Cause Inflation to Rise?

The huge and unprecedented fiscal stimulus from governments worldwide, coupled with the release of pent-up demand (due to pushing back of spending) can lead to rising inflation levels. Nevertheless, given the supply side shocks and the fact that economies will be operating with much slack, it is unlikely to materialise. Moreover, central banks have much leeway to raise interest rates to dampen any excessive demand side pressures.

How Should You Invest?

You Should Invest in a Diversified Portfolio of Assets

In an environment of high uncertainty, you should invest your money in a diversified portfolio. As always, diversifying your investments within asset classes and between asset classes is the best way to maximise returns with respect to risk taken . Ray Dalio does an excellent job of explaining the power of diversification in this video: Ray Dalio Breaks Down His Holy Grail.

You Should Invest in ETFs Not Individual Stocks. Look Out for Expense Ratios

In the little Book of Common Sense Investing, John C.Bogle advocates for the use of low cost index funds in a portfolio to ensure safe, stress-free returns. The power of ETFs is especially significant in an uncertain environment where the revenues of companies are difficult to forecast. As such you should invest your money in ETFs that track broad-based indexes like the S&P 500. Additionally, avoid high expense ratios: while the numbers can look small, a 0.3% expense ratio can be significant when the markets are only providing a 3% return (High P/E ratios).

Markets are at an all-time high, Expect Low Returns From Investments

In the months following March, the stock market has rebounded to all-time highs while COVID-19 is still ongoing. Thus, investors are paying far more for each dollar of earnings. This is driven mainly due to 3 reasons:

IMF World Economic Outlook: Impact on Price/Earnings Ratios of Major Economies

IMF World Economic Outlook: Impact on Price/Earnings Ratios of Major Economies

1. Huge Policy and Fiscal Response

A total of 6 trillion direct tax and spending measures announced and implemented worldwide has maintained disposable income for households and projected cash flows. Moreover, central banks around the whole have been fast to conduct quantitative easing by buying government bonds. This coupled with the lowering of the Fed Funds Rate to 0.25% has injected much-needed liquidity into the financial markets and prevented a recurrence of the financial catastrophe in 2008–2009.

2. Positive Vaccine News

The recent news from both Pfizer’s and Moderna’s Vaccines achieving 90% and 94.5% effectiveness in preliminary analyses has renewed hopes and optimism regarding a vaccine bailout.

3. Low Bond Yields and Low Inflation

With bond yields and inflation levels as low as it is now, investors worldwide have been flooding to equity markets in search of yield. This is in part because of the lowering of expected returns from equities due to a low risk-free rate (10-year treasury rate). Thus, investing in bonds will reduce portfolio yield and can also subject you to interest rate risk.

IMF World Economic Outlook: Impact on Ten-Year Government Bond Yields for Major Economies

You Should Invest in Gold as a Hedge Against Uncertainty

Given how unattractive bonds are right now, most investors will be taking up a position in equities. Thus, taking a small portion of your portfolio and putting it in gold can act as a good hedge in the event of bearish news and uncertainty. However, given the recent surge in gold prices, you should exercise some caution when investing your money in Gold as the prices may already reflect the undying uncertainty.

You Should Invest Globally to Hedge Against Country and Currency Risk

With the Federal reserve pumping huge amounts of liquidity into the markets, expect continued downward pressure on the USD. Moreover, with the Chinese economy recovering much faster than its counterparts, expect outflows from major economies into China. You should also invest your money in Chinese assets to gain some exposure to China.

Things to Look Out for That Will Drive the Recovery

1. Fiscal Stimulus

The current situation in US congress where Republicans have control of the senate while democrats take control of the house could lead to arguments over the stimulus package as we have seen over the past few months. This can be detrimental when companies and people most in need cannot receive aid timely. Thus, in the event fiscal stimulus is held up in congress, any Investments in US equities can be affected significantly. Look out for any updates of fiscal responses from governments worldwide and check out this database from IMF that details the responses: IMF Database of Fiscal Policy Responses to COVID-19

2. Future News Regarding The Progress of a Vaccine

With much of the forecasts riding on a medical bailout by mid-2021, watch out for any positive news regarding the production of a vaccine. Currently, Pfizer’s and Moderna’s vaccines having 90% and 94.5% effectiveness in preliminary analyses, the forecast of a vaccine bailout by mid-2021 seems likely. As such, investors should watch out for any news regarding the ability to scale up production and distribute it effectively. Moreover, a key point to look out for would be any news regarding improvements in refrigeration storage capabilities as this will significantly impact the ability to distribute the vaccine. As of the time of the post, Moderna’s vaccine can be stored in refrigeration temperatures for 30 days while Pfitzer’s can only be stored in temperatures below -70 degrees Celsius which would be a logistical nightmare for distribution. As such, Positive news of vaccine storage capabilities and approvals by federal regulators can be positive for equity investments depending on economic recovery. Check out this article from the Washington Post: What You Need to know about the Moderna and Pfitzer Coronavirus Vaccines.

Final Notes on How You Should Invest

9 Economic Scenarios from McKinsey & Company

How you should invest during COVID-19 is dependant on your views on the effectiveness of government response and the state of the vaccine. With much of the stock market riding on positive news regarding the vaccine and fiscal stimulus announced by governments worldwide, take note of any negative news that can impact projections. At the end of the day, holding a diversified portfolio that hedges agains uncertainty and currency debasement while tempering your expectations of high returns will do you well during this pandemic.

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