15 November 2023

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Post-Pandemic Changes to Manage

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What effects resulting from the pandemic will persist in the long term, and which ones will be absorbed more quickly? What is the most likely scenario investors will have to face? According to analysts at Capital Group, high inflation, a labor crisis, and a simultaneous and unusual drop in stocks and bonds are the main areas investigated to outline possible developments in the reference scenario:

• A team of Capital Group experts analyzed consumer price levels in 22 countries in relation to the growth of the money supply. The rapid growth of the money supply, fueled by government stimulus measures during the pandemic era, massive bank loans, and low-interest rates, has led to a surge in inflation. In countries where there has been more economic stimulus, inflation has reached higher levels. Inflation is caused by an excessive amount of money chasing too few goods, and this is exactly what we are witnessing today (as Nobel laureate Milton Friedman stated: "Inflation is always and everywhere a monetary phenomenon"). For some analysts, the peak of inflation is behind us because the Fed and other central banks have tightened monetary policies. How far is the 2% inflation target? It depends a lot on how the Fed will react in the future. There are different scenarios, including a more inflationary one, but also the possibility of a return to deflation. If the Fed maintains its aggressive stance and tightens measures too much, a severe recession could occur. If it were to reverse course, high inflation expectations could take root in the real economy.
• Another effect of the pandemic is the labor shortage. In the USA, about 47 million workers have left their jobs for better-paying occupations, early retirements, or starting small businesses. The US labor market, however, has an unemployment rate near historic lows: the reason is that the US economy has not kept pace with pre-pandemic growth trends (considering the average annual growth of the workforce pre-COVID, we should have four or five million more workers than current ones). Wage increases are a variable that affects inflation, and to cool the labor market, interest rate hikes could be higher than expected: if the US economy were to experience a recession for the next 2 years, this labor crisis would be overcome but not in the most painless way.

Post-pandemic opportunities are emerging in various sectors in the stock market (transition to more sustainable energy sources and/or significant industrial changes. The numerous years of insufficient investments in commodities could lead to a new commodity supercycle). Many of the price distortions witnessed in 2020 and 2021 are coming to an end, which does not mean prices cannot fall further. However, there has already been significant price destruction, and many excesses have likely been eliminated from the market. Many of these companies will not survive, but some will emerge from this crisis stronger and more profitable.

According to OECD data, global growth is expected to further slow down in 2023, while inflation should gradually ease. Among the main causes of the pressure on stocks and bonds in 2022 (figure below) are inflation and rising interest rates. If the Fed manages to control consumer prices, the negative correlation between stocks and bonds at the core of effective portfolio diversification should return. Inflation is likely to decrease as the Fed and other central banks continue to raise interest rates and reduce their balance sheets. Monetary and fiscal support will decrease over the next decade as policymakers assess what went wrong: this would be a major shift from what we experienced in the last decade, which was largely defined by government intervention. Limited intervention could lead to more volatile markets than investors are accustomed to.