In 1348 the Black Death arrived in the UK. It would go on to kill over one third of the population and the whole of Bristol, at the time its second largest city. Its economic and social consequences were profound: the disappearance of much of the labour force meant that wages more than doubled for freemen, whilst villeins were able to dictate much better terms from their landlords, eventually leading to the demise of the feudal system. Edwardian Historian G.M. Trevelyan would claim that that the its impact “was as significant a phenomenon as the Industrial Revolution”
Whilst the scale of the devastation wrought by COVID-19 is likely to be more limited, I would expect the virus to have, like the mediaeval plague, profound long-term economic consequences, starting most obviously with the grounding of the global airline industry. Whilst governments have offered interest free loans to airlines to keep them afloat, ultimately their shareholders will have to pony up new equity to make good their losses. If the cash needed is so vast compared to their remaining equity, then appetite for throwing good money after bad will diminish to the extent that governments would need the exercise the last resort of nationalisation, wiping out legacy shareholders. It is likely that this process is repeated across various troubled industries.
The crisis will also accelerate trends that previously existed such as the trend to online shopping. Whilst Amazon and Ocado are obvious winners, the virus could be the final death knell for the shopping mall, already feeling the pressure from poor retail profitability but now with previously solvent restaurant and cinema tenants denuded of their customers. Similarly, food delivery networks such as Just Eat will see a pick-up in volumes from stay at home customers.
There will also be some left-field winners with business models that in normal times did not look credible like home workout outfit Peloton, who will surely benefit with gyms closing, even if its bikes are ridiculously expensive. With no live sport on the TV, we could even see a return to book reading, or perhaps a baby boom ahead.
The process would also appear to be accelerating the immediate demise of fossil fuels, a process exacerbated by the outbreak of a price war between Saudi Arabia and Russia. The consequences of a prolonged period of $20/barrel crude oil are equally profound and likely in my view to result in an underappreciated risk of political uprising in the Middle East. It is also not clear, given how little is known about the origins of the virus, the extent to which Chinese relations with the rest of the world, and particularly the US, will be permanently impaired.
Investors have already seen the impact of the virus on their savings. Many are now finding that although they hold shares in different companies, cheap passive ETF’s or active equity funds from varying geographies for diversification, those funds have in fact all fallen off a proverbial cliff at the same time. They all had something in common: they relied only on the continuation of the bull market and were dependent solely on positive outcomes. Widely derided in recent times for failing to keep pace with the bull market, the value of a long/short equity fund, with proven short alpha capability, has suddenly become spectacularly apparent. It remains to be seen the degree to which investors will heed this lesson in diversification away from beta products
In the immediate shock of the pandemic the market would also seem to have overlooked that the healthcare industry will be an obvious winner. Given the economic devastation, every government will be spending as much as possible on ensuring that virus pandemics do not in future regularly occur.
When there is evidence that the virus in under control then markets will begin to anticipate a normalisation of economic activity and stock markets will recover. But as with the impact of the Black Death on mediaeval England, our economy will never be the same again.
Barry Norris,
Fund Manager of the Argonaut Absolute Return Fund
March 2020