Christopher Dembik
Head of Macroeconomic Research
Summary: We will have much higher growth resulting from pent-up demand once most of the restrictions and the lockdowns have been materially lifted - Q1 outlook 2021
Our first assumption for this year is that we will have much higher growth resulting from pent-up demand once most of the restrictions and the lockdowns have been materially lifted, probably as soon as this spring in the United Kingdom and Israel, and from a vaccine rollout that is faster than expected. Our second assumption is that inflation will show up this year, and will come from the physical lack of logistics after years of underinvestment.
In many ways, the pandemic has been a trend accelerator, in particular with regard to digitalisation. It has transformed consumer spending habits for good, with consumers swapping the checkout queue for online shopping more than ever before, resulting in a greater share of e-commerce in total sales. Just for the United States, the share of e-commerce has jumped from 11.8% of total sales in Q1 2020 to 16.1% in Q3 2020. In the midst of the pandemic, only digital companies or those able to levy digitalisation were able to protect or, in some cases, even increase their revenue stream; others meanwhile, typically the store next door, were confronted with massive revenue loss due to the introduction of social distancing measures. To get around problems raised by the pandemic, there has been a lot more focus on and investment in online advertising, online systems and delivery from the corporate side, notably in sectors that were lagging behind. All of this is unlikely to change when stores reopen their doors again. The acceleration in digitalisation and online shopping will continue in the coming years, bringing out issues that had until now been overlooked.
One of the key issues that we identify is the lack of investment in infrastructure and logistics devoted to the digital world. While we may believe the digital world could exist by itself, this is a wrong assumption; the digital world does not exist independently from the physical world. It needs all the infrastructure and logistics from the physical world to keep growing and working properly. And if we accept that digitalisation will drive everything and online platforms will become dominant, we need to understand that we have reached the point where the lack of investment in infrastructure to source and build, and in logistics to deliver the products that these successful platforms sell, is becoming a serious constraint that is about to drive cost inflation higher.
This is already happening. The physical structure is unable to cope with a sudden and massive increase in demand. With consumers being locked down in their home countries with a massive amount of cash, they have gone on a spending spree for Asian-produced consumer goods. The shipping infrastructure does not have the capacity to handle such a sudden jump in demand, leading to a bottleneck situation where empty containers are stuck in the wrong location and freight costs increase for major shipping routes. We are currently in the unique situation of the highest-ever freight cost rates between China and Europe, and between China and the United States. This is a sign of global trade revival, but it’s also the sign of underinvestment and malinvestment in logistics, which is nothing new.
Physical constraints are likely to be a main driver behind higher inflation in the months and quarters to come, but this risk has not been captured by capital markets and traditional models such as the 5-Year, 5-Year Forward Inflation Expectation Rate, because we don’t have price discovery anymore. Capital markets do not reflect the real structure of the economy and are not influenced by free market forces anymore. Capital markets have entered a system of administered prices, either due to government impact through regulation or due to direct impact from ultra-accommodative monetary policy. This explains why inflation expectations are still way below the central bank’s 2% threshold, but it does not mean that there is no inflation in the real world.
In the years following the financial crisis, public investment was the major victim of fiscal consolidation efforts, especially in Europe. Policymakers will probably not repeat the mistake of reducing investment after Covid-19. It is a consensus forecast that we will have an explosion in demand for infrastructure spending in 2021 and in the years to come. In the United States, the Biden administration is expected to slide a massive infrastructure plan later this spring worth a few trillion dollars, as part of his “Build Back Better” program, and many more countries in the developed and emerging world are considering a similar move. While investment in infrastructure has been part of the government toolkit to relaunch the economy since J. M. Keynes, a new approach might be adopted this time, with a stronger focus on the delivery of new-related infrastructure technologies such as electric hybrid transportation refrigeration units in the cold chain industry, or the integration of automation technologies into existing more ‘conventional’ facilities. These have the advantage of impacting all industries and making existing infrastructure smart.
According to a survey conducted a few months ago by IJGlobal and M&E Global, 63% of respondents, all of whom are actively involved in the financing and delivery of infrastructure projects, expect that the post-pandemic period will give new-related infrastructure technologies a big push. And 50.7% consider that it will be a key part of the stimulus effort to reboot economies after the pandemic. Governments will be key to filling the gap in infrastructure investment and focusing on the delivery of digital infrastructure, not only by formulating new regulation and policies but also by acting as a direct investor. The interest in the investor community is already noticeable, with equity investors focusing on infrastructures that are sustainable and resilient.
This period will create remarkable new opportunities, specifically in the logistics space that is traditionally characterised by very low margins. We already see opportunities in health care logistics with the arrival of the vaccines, where entrepreneurs and investors are focusing on more specialised delivery and much higher-margin areas, such as cold supply chain.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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