If the coronavirus crisis taught us anything, it would be that the future of the world can turn on a dime and anything is possible. Jim McCormick gives us his takeaways from recent months and in his wildest imagination, what might lie ahead for the next decade.
So Jim, you’re in the habit of making forecasts. How severe do you think the effects of this crisis will be?
The level of confidence and certainty adopted by so many people about the evolution and shape of this crisis, the ramifications and how everything will change has been fascinating to observe. The situation and circumstances as we know them are utterly extraordinary and unprecedented. So how can anyone be confident or sure about how anything will be? I’ve heard a lot of views over the last few months — some have hailed it as ‘the great depression all over again’, with others even claiming that their cities will stay closed forever… I always find that in a crisis, the best approach is to step back and stay humble about what you don’t know. The rest will follow. That said, it’s been super interesting thinking about what all this could mean for the future, and being open minded about it has been a great exercise; but it’s more a question of what could be, rather than what will be. Generally though, many have been defining the future from a negative perspective — however much is plausible, and even likely. But what we don’t know is the most important part. The effects could be good, bad and ugly, or anywhere in between.
Okay, in that light – what do we know today?
We now have a good understanding of economic shocks and what one looks like. To be fair, every significant economic event I’ve experienced in my career (which has been far too long at point…) has been totally unique. And unique to the coronavirus crisis has been the service sector collapse — a reference point traditionally used to help anchor economic health. It’s truly remarkable that almost all services aside from healthcare have been shut down globally, and we know with 100% certainty that the negative impact on jobs has been immense. The level of policy response we’ve seen has painted a very clear picture about how big that impact has been. The best way to describe it is as a policy response fit for war time, with fiscal spending and bazooka measures at levels never seen before.
Will we go back to ‘normal’? What is ‘normal?’
When I think about reverting to normal, I always go back to my experience of September 11. During the first couple of days immediately afterwards, some of those uber-certain forecaster types I referred to in my first question claimed it was the ‘end of New York’. Others said that no one would ever want to live in the city again. In reality, the real estate market was down for a month. My view is that mean reversion is strong. And so we will probably, in all likelihood, revert back pretty much close to pre-crisis norms but with some small changes. I’m sceptical that the coronavirus crisis will fundamentally change the world as we know it today.
There are some unexpected outcomes from this that will be sensible and won’t go away, but they’ll be changes at the margin. And I’d like to think any change we do see will, by and large, be sensible and understandable. So we’ll be eating in restaurants again, but probably washing our hands more. And many of us will do a lot more working from home because it’s rational for companies to hold less real estate. Travel –we will still do it, but it will probably be a bit more difficult and more expensive.
The concept of deglobalisation has been growing of late, and it has had a strong undercurrent in this crisis. I don’t think many disagree with that, and I expect it is broadly assumed that deglobalisation will continue after the crisis. Developed countries will likely now make efforts to ensure their essential goods such as loo roll, dried foods and protective medical supplies are on shorter and local supply chains within their own boundaries — again, it’s a logical and understandable change.
In your 2020 Year Ahead you a laid out several core themes. Are any of them still relevant?
A core, but quite specific theme for us in 2020 was that we were optimistic on the outlook for emerging markets. Clearly there are a number of coronavirus-related reasons why now is not a great moment for the region. That aside, the bigger picture views we had for 2020 remain spot on. We are in a world of diminished monetary ammunition and while we didn’t predict the coronavirus crisis, we did say that in the event of a crisis, fiscal policy will no doubt become a much bigger part of the solution. And that’s what has happened — big government action is back — and, in line with our call, Germany is a great example. Their government has made much larger promises than any other country. Ultimately, Germany’s conservativeness over the last couple of years has proven to be the right choice. They’ve kept their powder dry so that when required to deliver fiscal ammunition they’ve been able to do so aggressively.
Some of our other more political themes such as Brexit, the US election and the China Trade War will also remain, though perhaps less centre stage for now and in a different shape to when we entered the year. I do wonder though, will the crisis change the feelings, attitudes and outcomes of these political events? I guess we’ll have to wait and see.
Talk to us more about the resurgence of fiscal policy. Is it here to stay?
The government fiscal spending floodgates have opened. No matter how quickly the economic impact of this crisis recovers, it seems unlikely that this paradigm shift in policy is going away. For example, let’s say we do move from the crisis quickly and Trump wins the US Presidential election again, I wouldn’t be surprised if the next thing he announces is a massive infrastructure programme. Meanwhile, central banks will use this crisis to keep policy very easy for a sustained period. If everything bounces back in the second half of 2020, central banks aren’t exactly going to take away the policies they put in place.
How will this ‘paradigm policy shift’ affect yields, risk premia and asset prices?
As I’ve explained, this paradigm shift has a much larger emphasis on fiscal policy; but, combined with what I call ‘pragmatically irresponsible central banks’, it will likely see higher yields, steeper yield curves and higher risk premia across asset prices. It’s basically an entire reversal of the past 10 years, which was all about central bank bond buying and central bank easing. You’re basically turning the last 10 years — or you could even argue that it’s turning the last 30 years — on a dime. And that will start to happen pretty instantly I think. Then once we’re actually into what should be the period of recovery (probably the second half of 2020), higher inflation will eventually rear its head…
After years of low inflation, the prospect of a rise is a big topic now with people on both sides of the fence. Why are you expecting higher inflation and for how long?
In realistic terms, what next for inflation is indeed a pretty raging debate at the moment, understandably so. I stand on the side that when the dust settles, the foundation for a period of prolonged inflation is indeed there. It’s pretty interesting because if it happens it will be for the first time in 30 years that anyone has really thought about it. There is no playbook for inflation because my guess is that for 98% of the people in this industry, all we’ve ever had is low inflation. So if it comes, it will completely alter the investment world as we know it.
Like the inflation story, another raging debate is around the growing dominance of Asia. What’s your take on the West versus East outlook?
In terms of timelines, this wacky forecast is probably more on a 20-year horizon, but the chance of the Chinese renminbi becoming free-floating in the next 10 years is definitely possible. I do feel like the gravitational pull of power towards Asia is being underappreciated. In the West, it is generally thought that the US will always be the world’s super power, but I don’t buy that. Asia is now a more homogenous economic zone — and I expect it to become front and centre. Why? Well there are lots of reasons, but some of the key ones are that Asia is in less debt, has a lot of advanced technology and better demographics with a bigger population overall. Asia is a force that isn’t going away, especially China. But they are the new kid on the block and it will take them a while to shake that image and to build trust.
Looking back over the last 10 years, there have been a number of failures and divergences from the traditional Western model and ideologies, with big consequences to boot. For example, the UK and US were at the centre of the global financial crisis in 2008 and they, as well as Europe, suffered immensely in the aftermath. More recently, the West has been a thriving hub for the growing populist movement resulting in Brexit, Trump and shifting governments across Europe – I’m not saying this is bad or good, it’s just a clear anti-establishment trend. And now, the West has been among the worst affected globally by the coronavirus with critics holding up the UK and US especially as bad examples. All this considered, it begs the question – has the Western model run its course?
There has been lots of talk about how Europe will fare in the aftermath of coronavirus, are you optimistic?
A full fiscal union in Europe is actually worth considering for the next decade. Strangely enough, this may be the right crisis to finally answer the question around whether Europe can manage a fiscal union. Because if there was ever a reason to consider mutualising debt for instance, the coronavirus crisis would be it. The debt incurred today isn’t any one country’s fault, they didn’t ask for the coronavirus crisis. Sometime in the next year or two I think we could pose that ultimate question about whether Europe is ready to take their relationship to the next level and get married, rather than just live together! But remember, these things do take time. It’s easy to look at the mess that Europe is in and forget that the US had its own fiscal union growing pains, and it took nearly a century to resolve.
The truth is it was always a bad idea to create a monetary union in Europe before agreeing the fiscal side. As a result they created this unstable child called the euro. Rightly or wrongly, I do think that the coronavirus is going to answer whether Europe can stick together. The outcome of that on both sides, obviously, is a pretty big event. The outcome on the wrong side probably sees the next crisis. If Europe does actually divorce, it will be messy to say the least.
The market landscape has already undergone immense change since 2008’s global financial crisis. What unthinkable change might we see in the next 10 years?
There’s nothing like looking at the past 10 years to predict the next 10 years! We know that index investing and exchange traded fund strategies have overtaken the popularity of active management for some time now. In fact, headlines at the start of 2020 warned active managers that the decade was not going to be kind to them. When I think about the idea of active management making a comeback, it doesn’t seem totally crazy to me. But I do imagine that I’m in the minority on this one, and for many, the decline of passive investing would be unthinkable.
Investment strategies aside, a significant and very possible change that the market could see is a change in the long-held (negative) perception of banks. The global financial crisis (GFC) was always a banking system problem which was left unchecked for some time. Bank balance sheets were eroded after the GFC and that’s one of the main reasons why we’ve seen a prolonged period of central bank dominance, because they’ve had to help by providing liquidity to the market. But the past 15 years has seen a complete overhaul to the system thanks to massive regulation and banks have spent years building up stockpiles of capital while restoring their health and reliability. For the coronavirus crisis, capital rules have been eased and banks have now been able to use that capital in the marketplace. It’s encouraging, and hopefully this might see a more partnership-like focus with society and governments for banks going forward.