A look at the effects of the pandemic on macro and microeconomic levels.
We’re wrapping up 2021 with a look at a subject that has affected us all—the COVID-19 pandemic.
From Thrivent Asset Management, welcome to episode 20 of Advisor’s Market360TM. A podcast for you, the driven financial advisor.
Early in the year, with vaccines coming online, hopes were high for an end to the pandemic. And yet, here we are at the end of the year, still battling against COVID-19. The reasons are many—the variants, vaccine hesitancy and the vaccine’s waning protection. And while the health of people is, of course, the biggest concern, the effects of the pandemic on the global economy cannot be ignored.
In this episode, we will look at the economic impact of the pandemic from a variety of angles. But before we get to that, it might be helpful to do a quick refresher on the interplay of macro and microeconomics. Matthew Finn, CFA, Head of Equity Mutual Funds will be your economics professor emeritus.
As Finn explained, macroeconomic statistics, such as gross domestic product growth, unemployment, and inflation, provide the headlines that tend to influence the overall direction of the equity and bond markets. These statistics also garner the most attention from economists, policy makers and the press.
However, when managing a portfolio of securities – especially equity securities – both macro and microeconomic impacts come into play. Specifically, we look at how macro developments influence micro impacts and subsequently overall investment returns. One example is the recent sharply higher inflation and its potential impact on corporate profits.
Microeconomics provides information on the interaction of supply and demand which ultimately determines price trends for materials, goods, and labor. At a macro level, inflation statistics are a comprehensive snapshot of overall price developments in an economy. But at a micro level, inflation dynamics affect corporate pricing power, revenue, and input costs. Obviously, profits are a function of the degree to which revenues exceed costs – and it is profitability that ultimately drives a company’s stock price.
The pandemic has added a unique dimension to the multiple issues and risks that face corporate managers. It has also provided unique opportunities for various companies that are able to adeptly navigate a new and changing environment. Understanding these changing microeconomic dynamics and appropriately positioning portfolios for long-term success is a key challenge now facing investment managers.
Let’s go deeper on the current macroeconomic environment. Prior to the COVID-19 pandemic, the economic and business environment was characterized by several long-running factors that were keeping inflation extremely subdued. Finn identified seven such factors:
One, the lingering effects of the 2008 financial crisis.
Two, sluggish global growth, especially in Europe.
Three, a decade of extremely accommodative monetary policy by the Federal Reserve, or Fed.
Four, global overcapacity in many industries.
Five, depressed commodity prices.
Six, offshoring of supply sources and manufacturing to lower cost countries, especially Asia.
And finally, seven, stagnant real wages.
As consumers, businesses, and governments became more aware of the serious consequences of COVID-19, all reacted in ways that altered some of these factors. Consumers immediately stopped spending and began saving at a level not seen in decades. Businesses responded by cutting production of goods while pulling back on investment spending.
Finally, the government responded by showering the economy with money; first with a monetary policy initiative by the Fed that injected substantial liquidity into the financial system, followed by massive fiscal spending programs that sent dollars directly to consumers and businesses.
Meanwhile another long-running development became evident – the profound improvement in productivity delivered by advances in technology: computing power, software, and broadband internet connectivity. These advances provided the key infrastructure that allowed for economic activity to continue – and for certain industries and companies, to actually flourish.
So how did these macro factors affect the micro environment during the pandemic? First, supply was sharply reduced by private enterprise reacting to incredible uncertainty. And this was happening while higher demand was being fueled by massive fiscal and monetary public policy support. This led to significant micro imbalances across industries. In short, resurgent demand was met with sharply constrained supply, leading to dramatically higher prices.
What will be a critical dimension for equity investors to assess is the impact of shifting microeconomic variables – and the strategies that corporations will be pursuing to manage these new risks and opportunities.
As corporations continue to contend with the pandemic into 2022, they will need to successfully navigate five key areas.
The first key area is material costs. This will more directly affect industrial, automotive and consumer durable-related companies. Rapidly rising energy costs will affect these industries, as well as the fuel-dependent transportation sector. The information technology and communication services sectors are largely immune from the pressure of rising material costs. However, they will have to deal with component supply and cost pressures, especially in semiconductors.
The second key area is labor costs. All areas of the economy seem to be affected by the limited availability of workers and sharply rising wages. This is especially felt in industries that employ a significant number of lower-compensated workers. The leisure, hospitality, food service, consumer services, construction and transportation-related businesses are all challenged with increases in pay and benefits essential to attract and retain workers. This is an area where well-managed companies that previously recognized the value of their employees – and who have assertively worked to develop and retain workers – may benefit relative to their competitors.
The third key area is logistics. The cost of transporting materials and goods to their end destination is a significant contributor to rising costs. Logistical challenges cut across nearly all manufacturing industries as COVID protocols and international quarantine mandates combined to snarl complex, global supply chains. While near-term logistical challenges are slowly being resolved, longer-term questions remain regarding the reliability of obtaining necessary inputs from far-flung suppliers. Companies that have more diversified supply sources, simplified supply chains, and more domestic supply orientation may be better positioned for this more secular challenge.
The fourth key area is the technology and productivity response. It’s not an exaggeration to state that technological innovation and productivity-enhancing investments were critical in supporting the global economy. In fact, many companies actually flourished in this environment, and were rewarded with sharply rising stock prices.
The pandemic also pushed companies to find cost reduction or efficiency improvements that lead to lasting productivity gains and sustained higher levels of profitability. Until now, the obvious beneficiaries of these developments were the large technology-oriented companies. However, astute managers across many industries who successfully implement innovative changes to their operations can also benefit. These benefits may come not just from managing costs, but also from changes that can fuel incremental revenue.
And finally, there’s key area five, environmental and social impact. Consumers, corporations, and investors have gradually come to understand the reality of environmental and social costs that come with economic activity. Fortunately, there are not just negative cost issues to manage, but also new positive dimensions of opportunity for forward-thinking corporations. A great example of this is the emergence of electric vehicles – a secular change in the auto and energy sectors.
Properly assessing and responding to various environmental or social opportunities and costs is beginning to become a differentiating feature of success for businesses across all industries. Understanding these impacts and changes is also increasingly important to successfully managing equity portfolios.
Perhaps the biggest question created by the pandemic’s effect on the economy is whether these impacts are transitory. Or not.
The Fed’s mantra regarding the question of inflationary impulses is that they are transitory. In certain areas, especially in the area of commodity materials, it seems that may be the case given that pre-pandemic secular forces may reassert themselves.
However, it’s difficult to see how cost pressures coming from increasing labor demands will be transitory. Once labor costs start to rise, they are difficult to subdue. So, from a macro standpoint, it is unclear if inflation will eventually settle back into the Fed’s target range of around 2%.
To corporate managers, the debate around whether or not inflation is “transitory” is less relevant. They need to deal with the micro challenges and opportunities the pandemic has created.
If we look at the impact of the pandemic through the lens of investments, what strategies make sense going forward? For investment managers, successfully navigating a portfolio will depend less on correctly assessing the macro elements that have been such a key driver to overall market returns over the past number of years. Focus should shift to the micro elements that will have various impacts on long-term corporate profits across industries. This will be even more important given the current environment where valuation across asset classes is at historically high levels.
Our view is that a key focus to successful equity investing continues to be the fundamentals of corporations and the industries in which they operate, even in this dynamically changing macro and micro environment. Finn and his team will focus on those companies that demonstrate the ability to achieve superior operating performance such that they are able to sustain long-term high returns on invested capital relative to their cost of capital.
Also contributing to this special report were Roger Norberg, Director, Equity Research, John Groton, Jr., CFA, Director of Administration and Materials & Energy Research, Brian Flanagan, CFA, Senior Portfolio Manager, Thrivent Mid Cap Stock Fund, and Jim Tinucci, CFA, Senior Portfolio Manager, Thrivent Small Cap Stock Fund.
Thanks for listening to this episode of Advisor’s Market360TM. This is our last episode for 2021. We will be back in mid-January will new episodes. All episodes are available on Apple Podcasts, Spotify, and Google Podcasts. Learn more about us at thriventfunds.com and find other items of interest to you, the driven financial advisor. Happy holidays and bye for now.
All information and representations herein are as of December 13, 2021, unless otherwise noted.
Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.
Thrivent Asset Management, a division of Thrivent, offers financial professionals a variety of investment products to help meet their clients’ needs. Thrivent Distributors, LLC, is a member of FINRA and SIPC and a subsidiary of Thrivent, the marketing name for Thrivent Financial for Lutherans.