I came across this fantastic piece by Frances Donald, Global Chief Economist of Manulife Investments and have been thinking about it all week. I think she does a tremendous job breaking down a very difficult topic into an easy to understand concept. The recovery from the pandemic won’t be easy and will happen in stages and it’s more likely to follow a pattern similar to what happens after a natural disaster than the normal pattern after recessions.
We’ve seen everything in the rapid rebound phase take place. Government benefits paid out were higher than wages lost during the lockdown period. Central banks around the world pushed interest rates to zero, started buying investment assets, or both. After a dead period in the usual spring selling season, house prices have roared higher both in Canada and the US. That house price increase hasn’t been just in a few large markets. Secondary cities and towns have even joined the stampede.
I think Frances Donald got the timing of a transition to Phase 2 almost perfect. Look at this chart of diners at seated restaurants in 2020 compared to 2019. That peak coincides with the end of summer. As the cooler weather starts to hit, restaurants lose valuable patio space and under the social distancing requirements, their capacity drops even further with no viable outside seating.
Added to the mix, government benefits are now starting to wind down. While many will be converted to employment insurance, a large swath of people will not qualify under the program. That’s another level of drag on the economy as fiscal transfer now starts to slow.
The really big unknown is the return to work. I used to take a train into downtown every day to work in my office of over 100 people. Because of social distancing requirements we can’t all go back to work. And I'm not the only one - driving by the train station, I can see that the parking lot is barely 10% full. Our general operating capacity has dropped and it will take an adjustment period for that to recover. All of the above are signs of the 'stall out', as Donald calls it.
Now what does this all mean? Well, I think this starts a trend towards de-globalization that could power the next decade, by which I mean a more narrow regionalization of supply chains. North American supply chains might focus on Mexico and Central America as the hub for low cost products, for example. The first step will be strategically important products like medicines and health supplies but more and more could start to transition just as it did with manufacturing in China years ago. Mexico stands to benefit in this type of world because they already have a manufacturing base that is fully integrated with Texas and California.
The second big trend will revolve around how we pay off the debt on government balance sheets. I think austerity is a big part of that. We may have to learn to live with fewer government support systems. I also think tax increases are the other way. They could come in the form of a straight increase to income or corporate taxes, or they could be changes to what is and isn’t taxable like capital gains or investment income.
We all need to be prepared for this stall out phase and understand how it will impact our own lives and livelihoods. It will be a period about surviving and protecting what you have built up to this point in your life. I don’t know what it means for investment markets. There will be opportunities to invest like always but I think it’s a mostly a time of patience and making sure your portfolio is properly diversified. Just like the old Scout motto says - always be prepared.