What has been the true economic impact of the pandemic?

  • To understand the reasons markets have been so strong over the past decade
  • To discover why such strong investment performance may not happen
  • To understand how the pandemic may have altered the outlook for the economy
What has been the true economic impact of the pandemic?

When the global economy and equity market collapsed in the early days of the Covid-19 pandemic last year, pessimism reigned among global investors. Not for long. Less than two years later it is almost as if the pandemic, accompanied by a brief recession, never happened.

Although the Omicron variant of the virus has brought new uncertainty to the outlook for worldwide health, the heady optimism shown in economic forecasts and asset markets for 2022 has been barely affected. 

As the global economy returns to normal, what can investors learn from the past decade, encompassing both the prolonged recovery from the Great Financial Crash and the two years of the pandemic? 

It has been a truly remarkable period, with extremely strong performances from all risk assets, led by large-cap growth stocks in the US market, especially in the technology sector.

Since 2011, total returns on US equities have averaged 13.7 per cent a year, with the technology-heavy Nasdaq index rising by a startling 21.4 per cent a year.

Global equity markets have been somewhat less impressive, but have still risen at the very healthy annualised rate of 9.3 per cent in dollar terms over the entire decade.

These strong returns from equities and other risk assets have not been fully matched by bond markets. Nevertheless, US treasuries have offered positive returns of 3 per cent a year.

As a result, standard 60/40 equity/bond portfolios have performed consistently well, especially in the US. Furthermore, risk parity funds, which raise the bond weight so bond and equity risk are roughly equal, have done even better, returning 8.7 per cent annualised since 2011.

It has been a golden era for investors who have remained consistently exposed to the two main asset classes. For the most part, these returns have been fully justified by economic 'fundamentals'. Looking back, there have been four main contributing factors.

First, equity valuations as the post-GFC recovery gathered steam in 2011 were attractive. For example, the Fulcrum asset allocation model, built by Juan Antolin Diaz’s team, was predicting US equity returns of around 9 per cent annualised over the medium term, slightly above average.

The Shiller CAPE (cyclically adjusted price/earnings – a measure of equity market valuations) stood at 20, compared with an average of 27 so far this century. There was plenty of room for equity prices to rise, relative to earnings and dividends.

Second, the decade recorded very high growth rates in corporate earnings and distributions to investors. In the US, nominal dividends rose by 9.1 per cent annualised, compared with 4.8 per cent for nominal GDP. 

The pattern of high returns to shareholders, compared with wage earners, continued.

Third, adverse supply shocks in the global economy were notable by their absence. Geopolitical crises, especially those leading to sudden spikes on oil prices, had been the prime enemy of stability and high returns in asset markets in previous decades, including just ahead of the financial crash. But in the latest economic cycle, the main shift in oil prices was downwards, when extra supply from American fracking caused the West Texas Intermediate – a major oil price – price to plummet by two thirds in 2014-16. Over the entire 10 years oil prices were broadly stable.