The reverberations of Covid-19 will take time to materialize. Such a dramatic and widespread event, which until recently has left governments and investors in a state of uncertainty, created new opportunities and changed the investment industry.
The increased attractiveness of remote work and online shopping upended business models around the world. The economy seemed to have changed, and government responses proved crucial to navigating turbulent times. However, government responses have also resulted in a mix of undesirable effects, with inflation skyrocketing and adverse economic prospects looming over the horizon.
Surviving the Pandemic Almost Unscathed
Early in the pandemic, many investors sought a wait-and-see attitude. Many others believed that this time is different and sought to either shelter money in a safe bank account, or invest in treasury bills and in industries like healthcare and high-tech. However, this time turned out to be no different. In the US, the S&P 500 Index that plummet by 35.4% on March 2020 regained all its value a few months later the same year.
Similarly, in the first few months of the pandemic, tech companies such as Amazon and PayPal benefited from their online retailing performance. Companies in energy and tourism lost the most value. By mid-2021, however, most stocks recovered, even surpassing their pre-corona value levels. Until recently, a handful of stocks have continued to rise undeterred, the most being the FAANG stocks (Facebook/Meta, Apple, Amazon, Netflix, and Google/Alphabet), along with Microsoft and Tesla. These stocks make up a large portion of the stock market’s returns in 2020 and 2021, and they are part of the Information Technology group. Other stocks that are part of Consumer Discretionary also fared well due to their structural growth in digitization and technology. The best-performing stocks in the early days of the pandemic were those that benefited directly from Covid-19 disruptions, such as when social distancing, remote commerce, and working from home catapulted Zoom and Amazon stocks to the top.
This is also true in Europe and emerging markets, where tech and health outperformed cyclical stocks. However, as the pandemic receded and economies started to open, most of the cyclicals recovered a great deal of their values. Demand for these stocks eventually gained momentum due to governments intervening with direct fiscal stimulus and monetary expansion. For instance, energy company stocks such as ExxonMobil and Chevron rebounded as global demand for oil recovered and financial stocks received a huge boost thanks to stimulus injections.
Cyclicals tend to outperform at the beginning of an economic recovery, and many could be poised for a particularly robust upswing given their historic undervaluation. In addition, despite the support received from governments, many retail businesses have demonstrated a remarkable Leaning to Adapt, mainly by improving customer experiences and taking full advantage of technology, cheap loans, and boosting productivity along the way. These businesses understood that navigating what seemed to be a long-standing crisis required them to invest heavily in modern technologies and build a robust and functional online presence.
The Good Side of Governments’ Intervention
The sectors that did well when Covid waned, such as the financials, real estate, and energy, have seen a robust demand not just due to their company-specific fundamentals, but also due to governments’ generous stimulus packages. This is particularly the case in the US, where policymaking favored a direct intervention. With Uncle Sam in the driving seat, the world followed suit; the EU agreed on billions of euros to help tackling the crisis with a particular focus on recovery and improving resilience.
To be sure, many businesses around the world have become highly indebted, fueled mostly by the need to survive the crisis with low-cost borrowing and accommodative monetary policies. More corporate debt means lower credit ratings and a loss of confidence from investors. However, confidence started to recover as soon as Covid-19 waned, and governments pledged support programs. This time too, the world has leaned that fiscal policy is as important as monetary policy to maintain confidence and keep economies afloat. Keynesian economics is back again as a viable and efficient policy.
In the Arab gulf, where the oil price is a gauge for economic growth, the picture isn’t much different. As Covid-19 hit, economies contracted and demand for oil collapsed by 70%. While this was considered one of the biggest demand shocks in recent history, the loss in value didn’t take much to recover and even increase to record highs; oil price rebounded to $80, the highest such level since 2014, before hitting the $120 level after the war in Ukraine caused a panic in the market and disrupted supply routes.
However, the financial resilience of the private sector in some of the peripheral countries of the EU was put into question for the lack of fiscal space that resulted from constraints on spending and debt accumulation. For instance, in countries like Italy and Spain, the number of bankruptcies at the end of 2020 added to EU’s financial distress. Though the EU initiated large-scale financial support to contribute to a greener, more digital, and resilient European economy, governments’ fiscal constraints continue to be a drag on growth.
The Bad Side of Governments’ Intervention
If the recovery in the US has somehow been faster and more robust than in the EU, the Fed’s early decision to raise interest rates to stem inflation has had its deep impact on stocks. Rather than blaming these decreases on Covid-19 variants, observers have attributed them to inflation. To be sure, stocks, being largely based on expectations of future earnings, are likely to lose even more of their value as higher prices for materials and labor continue to impact earnings and investors remain wary of further market volatility. Uncertainty about future economic growth is making headlines and complicating governments’ policies and companies’ profit strategies. The Federal Reserve has so far announced and applied multiple interest rate increases, but investors remain concerned that monetary policy is not sufficient to stem inflation and is likely to trigger a recession that would see markets in Europe and emerging countries following a similar path.
High inflation, which recently averaged more than 8%, has brought back memories of the US experiencing stagflation. Such a term only reveals what might come next: an extended period of high inflation coupled with slowing economic growth.
Conclusion
What might dampen inflation is the likely easing of tensions in Europe and world leaders pushing for tougher climate policies. Just like every turn in recent economic history, challenges offer a lot of opportunities: the private sector will come out of this less dependent on carbon and more adept at using an alternative sources of energy. At the same time, the private sector will once again apply business reduction measures and innovative profit strategies to prevent a steep decline in the value of its shares. In the meantime, gold and commodities will offer better returns as investors seek to shelter their investments in such safe-haven assets.
As the world has learned to adapt to Covid-19,
it will also learn to adapt to recessions, high inflation levels, and stock
prices falling. Against this backdrop, it might take some time before the oil trades
again at its reasonable price range of $60 to $80 per barrel.
