Life after Covid: the view of a long-term investor
By Generali Investments’ Research Team
THE ECONOMY: SUDDEN STOP, PERMANENT SCARS
- The economic and social costs of the Global Covid Crisis (GCC) will dwarf those of the Great Financial Crisis (GFC). Forget the V-shaped recovery; prepare for a “swoosh”. The key risk is “W”.
- Longer term, deglobalisation, tighter regulation & state intervention will weigh on potential growth.
- Despite unabated money printing, inflation will be dormant over the foreseeable future. The longer-term call is less certain, but digitalization and automation should offset the effects of deglobalisation.
- Asset prices will benefit, e.g. bonds and real estate. Even elevated equity risk premia may still be compatible with structurally higher price/earnings ratios.
- We screen behaviours through 4 dimensions (DARE): Digitalisation, Activism, Repression and ESG.
- Four trends: 1/ Less globalisation. 2/ More financial repression, e.g. QE for longer; and higher taxes for the rich & Corporates? 3/ More interventionism. 4/ Lower financial returns in the future.
- Investors will chase asset, geographic & factor diversification, Alpha, new Growth (MedTech, CleanTech, data protection, FinTech...), and real assets (long-term inflation uncertainty). Stretched valuation and liquidity mismatches demand a greater focus on liquidity and risk management.
- AM: Sustainability becomes more Social; Real Asset & Credit expertise matters more; Protection needs suit insurers; hybrid human & digital service prevails but big players win digitalisation race.
COVID AN ACCELERATOR OF EUROPEAN INTEGRATION?
- We see € sovereign ratings mostly on hold in 2020; longer-term challenge is daunting, but ECB backstop & temporary risk-sharing imply a shallower downturn in sovereign ratings than post GFC.
- The ECB stands ready to break more taboos (e.g. capital key buying) if baseline scenario of post-lockdown recovery does not materialize. The future is fiscal, but requires the ECB backstop.
- We see the (upcoming) Recovery Fund as a baby step towards a common fiscal policy; a powerful and permanent joint response is far-distant. ECB support is invaluable but growth-enhancing reforms and measured consolidation will be key to put debt-ratios on a downward path.
CORPORATE RATING MIGRATION & DEFAULTS: THIS TIME IS DIFFERENT
- We expect the peak in corporate defaults at 6% in this GCC cycle, lower than GFC (c.10%). But record leverage and weak growth will imply higher defaults for longer and lower recovery rates.
- Credit rating migration is underway; downgrades from A to BBB will outweigh record volumes of Fallen Angels. Circa 55% of the BBB- names are on negative outlook or CWN… the HY index is about to get much bigger, with Banks, Autos and Industrials dominating Fallen Angel volumes.
- Rating migration, spread moves, ALM/currency mismatches etc. are costly under SII. Careful management has helped GIAM keep default and migration risk well below market averages.
INSURANCE SECTOR: THE DAY AFTER
- Covid hurts Life more than P&C. Risk aversion penalizes unit-linked products; guarantees (in demand) will have to be wrapped in an innovative way to be sustainable for insurers.
- Fall in SII ratios implies greater focus on capital saving. Regulators will gradually tighten stance on IR mismatch & transitional measure. Shareholders to be penalized at the expense of Policyholders.
- Opportunities: Social policies (and ESG), green & digital revolution, M&A, run-off specialisation, new Protection (Accessible healthcare, mix annuity/medical care, Insurtech, Fraud & Cyber risk etc.).
- LDI trends: ‘Lower for longer’ rates and dividends reinforce the appeal of Credit, Private Markets & Distressed. More hedging, despite the costs. Preference for ‘low volatility’ and ‘quality’ factors, lower duration gap, and less capital-intensive products.