Covid-19: What Can Science Tell Us and What Are the Implications?

A Dialogue with Professor Gerard Graham FRSE / Introduction by Dr. Sandy Nairn.

Dr Sandy Nairn Chairman, Templeton Global Equity Group Investment Partner & CEO, Edinburgh Partners

Professor Gerard Graham FRSE

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Investment Background and Implications

The economic world has been convulsed by the spread of the coronavirus. Entire economies have been forced into lock-down, unemployment is soaring, gross domestic product has slumped, and emergency fi scal and monetary measures are the order of the day.

The root cause is a virus which is highly contagious with a significant mortality rate. The human toll is immense not just for those infected, but also through those impacted by the fi nancial and social effects of the isolation policy response.

For financial markets, understanding the medical response is a precondition to understanding how the virus and the economic impact will unfold. To help us through these steps, we have spent time with Professor Gerry Graham, who is one of our expert advisors in the area of biological sciences.

One cannot draw any inferences on fi nancial markets without fi rst commenting on the impact of science and those in health care and related fi elds in reducing the impact on the health of the population. We owe all of those involved a huge debt of gratitude.

In terms of markets, the single most important investment conclusion is that in 12 months’ time the COVID-19 virus is highly likely to have an effective vaccine and we will be dealing with the aftermath rather than the virus itself. It also means that within a relatively short period the markets will be able to treat the virus as a ‘bounded problem’ which allows risk/reward judgments to be made with much less uncertainty. This is critically important for pricing assets and reducing volatility. We think it is entirely possible that this reduction in uncertainty will induce a signifi cant relief rally in fi nancial assets.

Once the uncertainty over the virus is reduced, one would expect markets to turn their attention to assessing the valuation of assets in light of the condition of the global economy. This will quickly become the central question for investors. What is this world likely to look like?

It will be a world where the impact of extended suppressed interest rates and liquidity injections have left an overhang of poor-quality debt issuance, in our analysis. It will be a world where the impact of the virus has exacerbated an already stretched fiscal position, leaving very little fiscal capacity available to governments without the indulgence of bond purchasers. It will be a world experiencing one of the deepest recessions in living memory. It will be a world of low inflation, reflecting burgeoning unemployment and the deflationary shock of business failure. However, there will be mounting pressure for actions that are inflationary in nature. In the private sector, reorganisation of supply chains, lower migration and potentially onshoring are all obvious responses. In the government sector, fiscal and monetary measures together with increased health care provision are only part of what can be expected. On the assumption that a deflationary spiral is avoided, these actions all point to a world where inflation finally returns.

In this new world, leverage will likely be anathema and financial strength will be critical. For many companies, public and private, stretched balance sheets will have to be recapitalised irrespective of the available terms. To paraphrase the famous quote of Warren Buffet, it will be a world where the tide has gone out and we will discover who has been swimming naked. Notwithstanding the gloomy economic outlook that will have precipitated the receding tide, this should be the ideal hunting ground for discriminating investors with strong valuation disciplines.

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