Backdrop

As the pandemic crisis resolves, some industries may quickly bounce back to something very recognizable. Other industries – such as airlines, cruise lines, hotels, restaurants, sporting events, theater, concerts, and public transportation – may be impaired for a lot longer as we struggle to find a new balance. The impact on real estate is uncertain. Certainly, there is a short term hit to some sectors (namely, high density urban centers) and a benefit to others (suburban office parks), but we doubt the hit will be permanent in these real estate categories. The density of urban centers may decrease, but we believe that they will always have a certain dynamic element to them because of the economies of scale and high networking benefits.

Balancing disruption is innovation. We already see the creation of new businesses and models from low tech to high tech: personal protection equipment (masks and plexiglass panels), video conferencing, and telemedicine. Moreover, interest in the biosciences has increased and new supply chains will be built.

One key drag on growth will be the continued deglobalization that began in the mid-2010s. A huge wave of globalization started in the post-WWII reconstruction period and was sustained by a series of positive shocks: for example, the fall of the Berlin Wall in the late 1980s and the entry of  China into the WTO in the early 2000s. However, after the Global Financial Crisis (GFC), the appeal of free trade and immigration faded and reversed in the mid-2010s. At a minimum, we expect further deglobalization with tighter border controls and movement of strategic supply lines closer to home markets. In the long run, we believe that the drop in the expected growth rate will be minimal because there has been no destruction of physical capital and human capital  has not diminished, though it may take quite a while for the markets to absorb and reallocate both factors.

Another drag on growth in the short run is the growth of precautionary savings by households. A lot of people will likely spend less and we already see the savings rate rising as they build a reserve fund for emergencies. This should put pressure on short term rates to stay low as this stock gets build up. Offsetting this are corporations which are systematically dissaving.

The pro-active policies of the central banks in an effort to stabilize the credit markets have been a substantial development. Credit spreads immediately tightened and inspired rebounds in the equity market before any of these facilities were operational. This response has taken some of the refinancing risk and solves several liquidity problems, but many firms have long-term solvency issues that only an orderly restructuring can resolve.

Finally, the huge increase in government deficits across the globe is a natural reaction to the resulting slowdown from the COVID-19 pandemic, though perhaps unprecedented in size and speed. The market is pricing in very little inflation risk premium. But this could change; for example, if policymakers over-stimulate amid supply-side constraints, inflation pressures could emerge.