Everyone knows that the four most dangerous words in investment are ‘it’s different this time’. Sometimes, it is. More often, things end up much the same. The challenge is knowing which it will be.
My investing lifetime has witnessed some seismic changes and the associated market reactions to them. The dot.com bubble and the financial crisis have been the most striking examples. In both cases, there was no shortage of people claiming to spot the end of one era and the start of something quite different. Very often during the 40 years from the end of the 1970s until Covid the pre- and post-crisis worlds didn’t look so very different.
So, my instinctive response to an investment bank research note arguing that the pandemic has changed everything is scepticism. This reaction is always magnified when the word ‘postmodern’ is thrown into the headline for effect. For the same reason that you don’t ask a barber if you need a haircut, you might beware of asking Goldman Sachs if you should be ‘positioning for secular change’.
But I’m being a tad unfair. The note does highlight four important ways in which the past two years may have radically altered the landscape for investors. Only time will tell whether this necessitates an overhaul of our portfolios, and it would be great if we could wait and see. Unfortunately, that isn’t how investing works. In the absence of a crystal ball we have to judge now whether the changes are as drastic as billed - and act accordingly.
No surprise about change number one - the re-emergence of inflation after a long hibernation. Arguably, it was tamed by Fed chairman Paul Volcker in the early 1980s and kept in its box for 40 years by a fortuitous sequence of events that included the de-politicisation of monetary policy in the 1990s, the emergence of China as a source of cheap labour from 2001 and finally the deleveraging and demand shock caused by the financial crisis in 2008.
The pandemic brought this happy run to a halt, with households buoyed by stay-at-home savings and wage support schemes in connection with coronavirus lockdowns, and the inflationary impact of gummed up supply chains and the war in Ukraine more than offsetting the initial fall in demand during lockdown. Central banks are now running to catch up with the potential wage-price spiral that threatens to lock in inflationary expectations. We have been here before. In the late 1960s inflation was not a problem until it was suddenly a big one. And investing in an environment of persistent inflation is clearly going to be very different from what served us well during four decades of relentless disinflation.
Change number two was in evidence well before Covid, but the virus and the war have accelerated a process that was already underway. About the same time that inflation was being Volckerised by the Fed, governments on both sides of the Atlantic were setting in train another revolution. The era of deregulation and privatisation may look as dated as big hair and shoulder pads, but it took a pandemic and war to confirm the fragility of the globalised economy they enabled. Localisation, resilience, and national champions will be the successors to complex, interconnected systems that require everything to go right without fail and which have let us down when that happen.
The third change highlighted by the Goldman Sachs note is related to the first two. Most of the past 40 years have been characterised by cheap and abundant labour and commodities, which removed the need to invest in greater efficiency that was one positive outcome of the shortages and high cost of both of these in the 1970s. The move from global to local will make labour markets ever tighter in future while it will take years to repair the lack of investment in commodity production, even assuming the ESG agenda allows it. For investors that means taking a much closer look at companies’ exposure to energy and labour costs, because the winners going forward will be those less affected by these inputs and those helping other companies to mitigate their impacts through technology and other efficiency measures.
Change four, and the one that may turn out to be the most consequential for investors, is the political shift from small to bigger and more interventionist government. We have moved a long way from Ronald Reagan’s assertion that government is not the solution but the problem. And from the government surpluses that this hands-off approach enabled.
Here, too, the pandemic has been more influential than the financial crisis, which also initially prompted higher government spending but then replaced it with austerity thanks to a belief that bailing out banks was a form of moral hazard. There has been less squeamishness about pandemic-related spending and the habit may be hard to break in an era of more overt populism.
Social and welfare spending is likely to be just the start of it. The new Cold War ignited by Putin’s aggression in Ukraine has encouraged governments to seek to increase defence spending and they have been pushing on an open door. President Biden secured a bigger defence package than he first asked for after both sides of the House thought he hadn’t gone far enough. Germany’s defence U-turn has been broadly welcomed at home.
And that’s before we have even started to talk about the twin imperatives of de-carbonisation and greater energy security. Put this all together with an older fixed asset base than at any time since the 1950s and there may be a capex boom in years to come.
Does this alter everything for investors? Are we really entering a new postmodern era? Should we let our friends at Goldman Sachs reposition our portfolios for secular change? That depends whether you agree that it really is different this time.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
