John Redwood reflects on the impact of the crisis and how it will boost trends apparent to investors before the pandemic.
This week, the Western world changed dramatically. The US, Germany, France, the UK and many other advanced economies, saw the imposition of new strict controls or tough guidance to reduce people’s contact with each other.
Most of the measures target hotels, restaurants, travel, sport and cultural events, theatres, cinemas, gyms and clubs. Airlines, taxis and car hire are particularly vulnerable in the travel industry. The aim is to stop or discourage people enjoying any of the usual entertainments and tourism, as these are possible means by which the virus spreads more rapidly to more people.
This will cause a sharp downturn in activity. In a normal recession, the downturn builds more gradually. The most exposed companies offering luxuries or discretionary items suffer larger falls in turnover than those producing the basics of everyday life, but they still keep substantial business.
In this crisis, many businesses in these affected areas will simply have to close, losing all turnover overnight. They are large employers of labour, so there will be substantial job losses, unless governments step in to pay employment subsidies to businesses to keep on staff without customers.
Some of the larger businesses have a spread of interests that helps. Some will be able to earn some revenue from a rapid change of business model. A restaurant, for example, may be able to sell meals for home delivery from internet orders. The hit to these businesses overall is very large and will depress the economy and knock confidence.
On top of the health crisis, Russia and Saudi Arabia have chosen this moment to cut oil prices and undermine expensive oil production elsewhere, and new oil investment and development.
There will be some companies gaining revenue on the other side. As meals out are cancelled so more food will be sold direct to retail customers through food stores. In the short term, they will also sell more as people build up higher stocks.
As cinemas close, so more people will download movies from online entertainment services. As trains and buses lose customers who work from home, so the suppliers and service businesses supplying laptops, iPads and business connectivity will do well from a new army of homeworkers.
Makers of hand sanitiser gel, cleaning fluids, cold and flu treatments and their retailers will also see a surge in demand. The overall net impact will be substantially negative. So far, most shares have fallen sharply with the market, although of course the most at-risk sectors and companies have fallen the fastest.
The central banks have responded strongly to the challenge. Rates have been cut dramatically by the Fed and brought down by the Bank of England. The Fed, Bank of Japan and the European Central Bank have announced more quantitative easing. Most countries have put in place programmes to try to ensure adequate credit lines for business to borrow against a temporary downturn. Considerable liquidity has been released into markets to handle the volume of sales and to offset some of the fears.
We are now passing to the phase where governments are announcing payments to reduce some of the economic damage the closures are doing. They are looking at schemes to keep people’s incomes up where they are faced with unemployment, with loss of self-employment income, or loss of some of their casual employment. They are also launching or considering schemes to let businesses off tax payments or to inject cash directly into businesses struggling for customer revenue. They need to do more promptly. The French president Emmanuel Macron has said that companies will not be allowed to go bust, which he hopes to achieve through tax breaks and credit lines.
So far, share markets have fallen to reflect the new reality of a sharp downturn and a substantial reduction in corporate profits overall. They are also adjusting relative valuations to the possibility that some sectors and companies will go into loss and there may be bankruptcies from the drying up of turnover. This in turn affects the company debt or bond markets.
Companies that have borrowed to grow their leisure and hospitality business, or to drill for expensive oil may struggle to repay. After a period when many investors bought risky bonds because interest rates were low and economies were still growing, we now live in a climate of more fear about some of these companies’ ability to honour their debts. Bond investors have shown a preference for safer government debt, despite the very low income available on it.
What will turn this round? Buyers will return in bigger numbers when we can see an end to the closures and a pathway to a more normal economy. This will require the authorities to succeed in controlling the spread of the virus, or a change of approach that allows more economic activity and living with the virus. The latter is easier once there is a vaccination to give more people immunity to it.
In the meantime, this stress looks like another boost to trends already apparent to investors before the epidemic. There will be more flexible working. There will be more online shopping and less bought in shops. There will be more online entertainment, education, information and work. The digital revolution will make more advances at the expense of traditional business models.
In due course, their success will benefit shareholders. There will also be a substantial increase in the role of the state, which may lead to more moral or legal controls on company pricing, profits and remuneration. As the state makes a more active contribution to company finances, so it will wish to make sure that its money does not result in excess dividends, bonuses and pay.
John Redwood is chief global strategist for Charles Stanley.
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