Investing in a post-pandemic world

ARTICLE SOURCE: AWARE SUPER | AUTHOR: JAMES WILLIAMSON

Investors in a post-pandemic world are coming to grips with new problems, possibilities, and perceptions. We look at why markets have been rocked by changing conditions, and why in times like these it’s important to stick to the investment fundamentals.

Bottlenecks and inflation

The COVID-19 pandemic has sped up existing structural changes, created new investment opportunities, and introduced new risks.

A major structural change has been to reassess global supply chains. To reduce the effect of supply bottlenecks and increase resilience, there is a growing trend to reconsider the ‘old’ practice of offshoring whereby production is transferred abroad to reduce costs. Governments and companies have been looking to reshore production back home to reduce the potential for supply chain disruption, lower transport costs, and create more jobs at home. A complement to reshoring is the more recent move to ‘friend shore’ or ‘ally shore’ sources of supply to a country’s friends and allies to reconfigure global supply chains.

The ‘supply chain pain’ has been a major cause of sharply rising prices in many countries over the last year. Inflation, measured by the Consumer Price Index (CPI), has spiked above 8% in the US1 with food price rises of more than 10% (see Figure 1). Russian sanctions and the war in the Ukraine have also impacted oil and grain prices which were already rising, while COVID lockdown in China has squeezed global shipping supply. Meanwhile, demand has surged in most countries as economies opened up, households spent savings built up during the COVID period, and governments provided COVID stimulus relief.

Sustainability and stagflation

Many global central banks are lifting their cash rates to moderate price pressures. Higher interest rates have lowered the prices for bonds and many pro-growth shares. Higher inflation and interest rates have many investors worried about a return to stagflation – that is, rising inflation with stagnant economic growth. We may not see a return to 1970s style stagflation of high inflation with more manageable debt, but rather a 1940s recipe of inflation and high debt. Recession is also a risk.

International agreements and obligations, and a more significant green representation in governments are also competing with an immediate need for energy and food security. This is another short-term risk for investors looking to balance the imperative of investing sustainably and addressing climate change should economic conditions deteriorate further.

Because we believe that investing sustainably and actively managing environmental, social and governance (ESG) risk will deliver improved long-term returns for our members, we remain committed to being a responsible owner, not just an investor. By effectively managing ESG issues, we can help the companies we invest in find new opportunities, steer capital towards more attractive areas, and manage long-term investment risks.

Australia hit by inflationary headwinds

Australia has been somewhat insulated from these global economic troubles. As a resource-based economy, Australia has been able to weather economic storms more than many economies because resources prices are generally more resilient in an inflationary environment, thus supporting the economy.

But this year Australia has been hit by inflationary headwinds, with the annual rate of CPI inflation accelerating to be slightly north of 5% at present1. A strong post-COVID re-opening, supply shortages, employment growth with upward pressures on wages, and healthy household finances and demand, have combined to push up prices.

Key risks for Australia are low immigration acting as a brake on the economy, the impact of fast-rising interest rates on house prices and affordability, and an indebted household sector.

Looking over the valley, investing beyond the dips

The brittle investment environment has been clearly evidenced by weak share and bond market returns this financial year. Risks abound, but economies are cyclical as are many human and natural processes. Market pullbacks may seem bad in the short-term but are often essential to reset to a more sustainable growth path.

While we don’t know exactly how these forces and risks will play out, we do know that markets will continue to scrutinise central bank policy (especially in the US) as they try to control inflation – whether they can deftly engineer a ‘soft landing’ of low growth but no recession or drive economies onto the recessionary rocks.