The COVID-19 pandemic saw unprecedented levels of monetary and fiscal policy support provided by governments and central banks around the world, as they responded to the uncertainty created by the initial outbreak, vaccination uncertainty, vaccination roll-out delays and then to numerous variant outbreaks.

It has not been an easy road, and while policy support has allowed the global economy and financial markets to recover much faster than expected, the pandemic has come at a great cost to human life.

This article contains the views of a selection of leading domestic and international investment experts on the post pandemic world. Their insights are provided at what is considered to be an important juncture for the global economy and financial markets, which have had to navigate a global pandemic over the past two years.

These investment specialists believe 2022 will be the first year since the onset of the pandemic where COVID-19 will become endemic and where the health and economic implications can be more clearly separated. In other words, over the past two years, economic outcomes have been closely linked to health outcomes. But given high vaccination levels across the developed world, policy to deal with COVID-19 has now shifted from lockdowns to living with the virus.

Encouragingly, the global economy has now recovered its COVID-19 losses, with equity markets well above pre-COVID-19 levels because of ultra-low policy rates boosting valuations and supporting relative attractiveness of the asset class. But, with economic growth rates now starting to normalise, labour markets showing signs of stress via shortages driving rising wages, inflation at multi-decade highs across any number of developed economies, and policy rates still set at emergency levels, it is clear that the world is emerging from the pandemic in much better shape than expected.

In addition, the need for such accommodative policy settings has passed and we are entering the next phase of the economic cycle where growth rates begin to mature, and the tailwind of easy policy begins to reverse. This is a dramatically different backdrop from that of the past two years and, on top of structural shifts brought about by the pandemic, will mean investors will need to lower their expectations for risk-adjusted returns in the coming 12-months and beyond, according to these experts.

What are the long-term implications from the pandemic?

The past two years have come at great personal and economic cost for many households, businesses, and governments. But out of adversity comes opportunity and our investment experts, are genuinely encouraged as they look towards a ‘post pandemic’ world.

While it is difficult to focus on the positive outcomes of the pandemic when its negative effects continue to linger, these investment specialists believe there are many developments that will help shape the path of household and corporate behaviour, government policy and investment trends in a constructive and more inclusive way, as we move into a post pandemic world.

Since the onset of the pandemic, we have seen a tectonic shift towards inclusiveness and in attitudes towards tackling social and environmental problems. There are costs to these changes, but these are far outweighed by the costs of doing nothing, according to our panel of financial market experts.

Several structural trends have been accelerated because of the pandemic and our panel are united in their belief that the pandemic has turbocharged four major structural shifts that were already underway, albeit at a more glacial pace. These include:

1. Increased adoption of health and wellness initiatives into the workplace, including embracing of the hybrid working model that has become mainstream out of necessity, rather than choice.
2. A further shift toward deglobalisation/nationalisation and a more multi-polar (meaning fragmented) world, as countries used the pandemic to look inwards in an attempt to protect health outcomes, secure strategic goods and services, and pursue populist policies. In addition, the recent outbreak of war between Russia and the Ukraine is furthering this shift towards a multi-polar world, as it fragments Europe and the ‘Anglo-sphere’ bloc, and brings together Russia and China.
3. An acceleration in digitisation as mobility restrictions during COVID-19 drove online activity from the purchase of goods and entertainment, to physical exercising and share trading.
4. Refocused efforts on the need to address environmental (predominantly climate) challenges, as the pandemic drove a more altruistic and considerate view by consumers through to businesses and governments.

From an Environmental, Social and Governance (ESG) perspective, COVID-19 and the global response to the pandemic has demonstrated these issues can have a broader impact on the world if not managed correctly, because ESG transcends borders.

In particular, COVID-19 has significantly increased the discourse around the ‘social’ aspects of ESG. For example, supply chain disruptions are currently dominating headlines, and investors and consumers are more aware of the underlying layers within supply chains and therefore, are more considerate of the risks surrounding modern slavery and human rights.

This is seen as companies shift to prioritise and address worker health and safety, with corporates now investing more in local manufacturing and employees, as well as adopting a ‘just in case’ rather than a ‘just in time’ strategy.

For financial markets and investors, while they have been given an adrenaline shot via unprecedented levels of cheap and plentiful money, there is a growing distinction between those who are embracing social and environmental change and those who are not, and this is being borne out by where capital is flowing and at what price, as the focus is heightened on the planning towards, and implementation of, operational ESG initiatives.

As we move deeper into the current cycle, investors and their financial planners will likely need to work harder for their returns (which is normal, as the economic cycle matures) and continue to look outside of traditional asset classes in order to diversify and thereby reduce risk in portfolios.

Additionally, having seen episodes where correlations between traditional assets breakdown and fixed income cannot provide the performance cushion against equity market weakness, investors who are needing more robustness, less volatility and capital preservation during drawdown periods, will continue to drive demand for other assets (i.e. commodities, real estate, infrastructure, crypto currencies) and the use of alternative strategies.

For portfolio managers, COVID-19 has also positively influenced the approach to originating new investments, conducting due diligence and the transaction process – with operational efficiencies gained from the acceleration in the adoption of technology that is helping analysis and testing of factors, such as ESG and black swan events, in order to help de-risk and improve performance.

Active asset management and manager selection is also more essential now than ever, to ensure firms maintain their competitiveness. Mission-driven firms, such as those that incorporate ESG and other elements that are important to today’s talent pool, are more likely to attract the best talent in the market. So, managers need to evolve, or they may potentially face their own Darwinian fate.

How has geopolitics changed and what does it mean?

Geopolitically, our panel of investment specialists believe that the pandemic accelerated trends that were already underway globally, including increased nationalism, populism, and deglobalisation. This has led to more bilateralism versus multilateralism, more inwardness (for example, onshoring of supply chains), and less global co-operation (for example, vaccination figures in developing countries).

In many ways, these dynamics have sped-up the shift from a unipolar world to a more multipolar, fragmented global landscape.

Furthermore, recent developments in Eastern Europe, with the war being fought in the Ukraine, is also accentuating the trend towards a more multipolar world. This is because it is bringing Russia and China closer together, while driving greater separation between the U.S. and Europe (where the latter is more linked into Russia). It is likely that the world splits up into three groups made up of: 1) the Anglo-sphere (U.S., Canada, Australia, New Zealand and Japan); 2) the Sino-sphere (China, Russia, Central Asia, Iran, Turkey, Africa); and 3) the European Union (with some separation to the Anglo-sphere countries).

Finally, our panel of investment specialists also notes that at some point, governments will need to address the budget pressures and fiscal deficits created by the stimulus provided through the pandemic, although the appetite to do this against a backdrop of restrictive interest rate settings is likely to be low. Unfortunately, there is never a good time for austerity when money has been so cheap and freely available and/or when fiscal policy has been expansionary. The alternative (households spending less and saving more) is also a hard (and unlikely) pill to swallow.

What does the combination of structural shifts and less expansionary policy settings mean?

1. Economic and rates outlook: Rates won’t kill the cycle in 2022

Looking into 2022, our panel is optimistic on the overall global backdrop and expect the recovery to continue largely unabated. While it is a consensus view that growth momentum will decelerate from the extraordinary levels seen in 2020-21, it should remain above trend – driven by strong consumption, elevated savings, pent-up (services) demand, and continued easy financial conditions.

It is also expected that the pace of the recovery will vary significantly across countries, given different inflation trajectories that will drive an unsynchronised pace of policy tightening, as well as ongoing COVID-19 management. Global economies will likely be more desynchronised than they have been in recent years – with the U.S. economy red hot, China’s growth slowing precariously, while the European Union, Japan and the rest of emerging markets are somewhere in between.

Elevated and stickier inflation means our panel of investment experts expect a number of interest rate increases to be forthcoming from the Fed, and other central banks likely to follow suit – with the Fed having signalled plans to commence hiking rates in March and begin shrinking its balance sheet around midyear. However, as our panel highlights, the number and quantum of rate increases remain unclear and will likely result in continued market volatility and variability in the pace of economic recovery throughout the world. This elevated volatility will likely continue to dominate the macro-outlook and financial markets in the near to medium-term.

As inflation continues to dominate headlines, our panel agrees that the baseline scenario is for inflation momentum to peak and then moderate in late 2022, as goods demand slows and services continue to recover, inventory balances are restocked, supply chains normalise, and energy prices come down.

However, the persistence of inflationary pressures is expected to vary market-by-market at a global level. While over the medium-term, we are likely to be in a more inflationary environment compared to the last decade, our panel does not think that inflation poses a systemic risk for markets, given the willingness of central banks to start raising rates in response to inflationary pressures.

Our panel also considered the key upside and downside risks to the outlook. On the downside, there is general agreement on three key risks:

1. Persistent inflation, prompting central banks around the world to shift towards more aggressive monetary policy tightening;
2. Elevated geopolitical risks and in particular, conflict between Russia and Ukraine; and
3. Lingering issues from COVID-19, although the risk of a widespread disruption to global activity has now been greatly reduced.

Several panellists pointed out it is a fine line for central banks to walk between raising rates and ensuring inflation does not get out of control, versus holding rates down to stimulate the economy but ultimately creating asset pricing bubbles. As such, one key risk to the global economy includes central bank missteps where they over or under shoot the optimal balance. Such missteps could have ramifications beyond the cost of debt, ultimately impacting the ongoing economic recovery.

Domestically, our panel is positive on the Australian economy, and sees it outperforming the rest of the world over the next 12 months. Domestic growth is expected to be supported by continued strength in commodity prices, a strong housing market, strong job growth, high savings levels, and strong credit growth.

Nevertheless, the growth trajectory is unlikely to be smooth, with a slowing housing construction sector, rising costs and interest rates, and still muted population growth all likely to present some headwinds.

On the looming Federal election, our panel is unconcerned over the medium-term, as elections always create short-term uncertainty, particularly when the policies of each party are not highly transparent. However, the disruption is not typically sustained, and long-term fundamentals are likely to prove to be more important. In fact, there may be risks to the upside, which may result in consumer-oriented stimulus in the form of pull forward tax cuts and small to medium enterprise incentives.

2. Equity markets: Bull market still intact

On the global outlook, our equity panellists are somewhat cautious, but certainly not bearish. Although equities are still expected to outperform fixed income in the coming 12 months, headwinds are rising and a meaningful pull back would not be unexpected. While valuations have corrected, they remain relatively high, providing limited downside support if rates rise faster than expected or growth begins to slow faster than expected. Similarly, earnings upgrades are decelerating from 2021 and company guidance is less positive, with only a handful of stocks driving the market higher as breadth narrows.

Still, the advantages of the asset class remain, with equities typically offering better inflation protection than bonds and cash due to the ability for many companies to pass through rising input costs via higher prices.

Domestically, the Australian market is well positioned to outperform for several reasons: underlying economic fundamentals are sound, despite higher interest rates; cyclical sectors are to be supported by earnings tailwinds, as tapering starts; and both corporate earnings (excluding the materials sector) and dividend yields are still expected to be in the high single digits.

3. Fixed income – battling higher rates 

Our fixed income panellists are broadly in agreement that we have seen the lows for bond yields in this cycle and that despite a rapid rise (on par with the sell-offs in 2008 and 2020), our panel thinks long yields are likely to still go higher.

Policy rates are set to rise over the coming 12 months, which is likely to cause some indigestion for pricing in credit markets. However, broadly speaking, the credit outlook remains benign, supported by above trend economic growth and strong corporate fundamentals. Financial conditions are expected to tighten from ultra-easy settings but not by enough to threaten the growth of credit and equity markets outlook.

4. Real assets: Offering cyclical and structural upside, as well as yield support 

Our real assets experts are positive on the 12-month outlook for real assets. Increasing demand and capital flows from an investor perspective provide a tailwind for growth, albeit at a slower pace than 2021 and with some variability by region. The asset class’s inflation hedging characteristics, combined with current spreads to bond yields, which are within and, in some cases, wider than historical norms, should see investors continue to find real assets attractive.

5. Alternatives – return enhancement and diversification

Within private markets, our experts believe private equity will still outperform public markets over a longer time horizon, given the access to a greater range of companies, although a slowdown versus the previous two years is to be expected (given performance has been outstanding).

Given the popularity of private equity with institutional investors who don’t place as great a premium on liquidity, the illiquidity premium is largely eroded now. As such, our panel thinks the most important component of private equity investing today is finding the complexity premium – which can be established in a number of ways, such as specialisation, reputation and reliability, relationships, and exploring more fragmented markets.

Jason Todd is Head of Wealth Management Investment Strategy for Macquarie’s Banking and Financial Services group.

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QUESTIONS

To answer the following questions, go to the Learn tab at moneyandlife.com.au/professionals

1. What structural trends have been accelerated by the COVID-19 pandemic?

1. Increased adoption of health and wellness into the workplace.
2. An acceleration in digitisation.
3. Refocused efforts on the need to address environmental (predominantly climate) challenges.
4. All of the above

2. Which of the following is supportive of global growth in 2022?

1. More persistent inflation.
2. Strong consumption and pent-up services demand.
3. Rising interest rates.
4. All of the above.

3. Raymond is meeting with his financial planner, Jacky, to discuss the annual review of his portfolio. Jacky is considering some changes to Raymond’s portfolio. What are the key risks to growth in 2022 that Jacky needs to be aware of?

1. Higher and more persistent inflation.
2. Ongoing COVID-19 concerns.
3. More aggressive than expected monetary tightening.
4. All of the above

4. What are tailwinds for the Australian economy?

1. Rising interest rates.
2. Strong commodity prices.
3. Slow population growth.
4. All of the above.

5. Jeremy is constructing a diversified portfolio for his client, Susie. When considering the mix of asset classes, which asset class outlook is correct for the expected market conditions of 2022?

1. Equities is still expected to outperform fixed income markets.
2. Long bond yields have seen their highs and is expected to move lower.
3. Demand for real assets is expected to decrease.
4. The illiquidity premium remains critical in driving private equity outperformance versus public markets.