The challenges ahead on the road to recovery

By Garry White, Chief Investment Commentator, Charles Stanley

There will be a spectacular recovery in corporate revenues and profits in the second quarter of this year, as the comparable 2020 period was during the peak of global lockdown. Many companies will also return to the dividend list, as social-distancing measures are slowly eased. These upbeat prospects for this year have already been reflected in markets.

However, alongside the corporate recovery, the true cost of the pandemic will start to reveal itself. This is likely to temper any exuberance caused by rebounding corporate profitability. Many businesses – including property companies and oil and gas operations – will probably be forced to slash the book value of their assets because they are no longer worth what they paid for them. 

Some businesses will also discover that their markets have permanently shrunk. Many businesses may therefore find it difficult to survive, as online rivals make their business models defunct. The pandemic may also result in people changing their behaviour by, for example, avoiding large crowds.

Pressure to withdraw economically crippling social-distancing rules will intensify as the year progresses – and the expensive financial scaffolding that has buttressed companies, markets and employment will start to be dismantled. As these supporting structures are removed, we will get a clearer understanding of the permanent scarring the pandemic has inflicted. 

The winding down of state support schemes will also trigger an increase in corporate defaults and insolvencies. Zombie companies that have been kept on life support by taxpayer handouts will no longer be able to stumble on. It is a necessary process – but it needs to be carefully managed to prevent any fallout spreading into the wider financial system. 

The sectors most at risk of insolvencies and defaults are energy, retail and property. High-yielding debt issued by the US energy sector is likely to be problematic and default rates have already been on the rise.

Garry White

The “green revolution” that is front-and-centre of the European Union’s post-pandemic recovery plan is also now a central policy of the new US administration under Joe Biden. That means the energy sector, which represents the lion’s share of the US highyield bond market, faces an existential crisis too over the longer term. 

The UK Coronavirus Act allows the UK government to offer any financial support required to prevent, mitigate or compensate for the impact of Covid-19 on UK businesses. This has included government-backed and guaranteed loans, material contributions to the salary and wage bills of furloughed workers – and financial support for the selfemployed. When Chancellor Rishi Sunak issues his budget on March 3, it is possible that this support will be reduced.

Mr Sunak extended the UK’s furlough scheme in December. The Government will now continue to contribute 80% towards wages until the end of April 2021. Britain’s government has supported about 10 million jobs since the start of the pandemic at a cost of almost £50bn. This cannot continue. As this support is wound down, UK unemployment will rise – but it’s difficult to predict by how much. 

So, central bank policy and government fiscal responses looks likely to become a challenging balancing act against an unpredictable news backdrop. Those individuals making fiscal and monetary policy decisions will be faced with many difficult and contradictory choices about the quantum and rate of any change in policy. In such circumstances, mistakes can easily be made.However, despite the difficulties that policymakers face, it’s clear good progress on ending the pandemic is being made.