Markets and the economy will level off and become more stable as the world moves away from Covid-19, but the transition is going to mean a reversion to lower returns, according to Joseph Davis, global chief economist and the global head of the Investment Strategy Group at Vanguard.
The world will see a return to normal for portfolio returns over the next two years, but this will require action by the central banks to stem inflation, Davis said in a presentation at the opening session of the 2022 Advisor Growth Summit presented by Financial Advisor magazine. Davis said he wanted to put Covid in historical perspective and try to assess its long-term financial impact.
The legacy of Covid-19 will be a rising interest rate environment that presents opportunities for investors, as well as some challenges, Davis said. As head of Vanguard’s Investment Strategy Group, Davis leads the firm’s research and client-facing asset allocation strategies, including conducting research on the capital markets, the global economy, and asset-allocation strategies. He also chairs the firm’s Strategic Asset Allocation Committee for multiasset-class investment solutions.
Davis compared the lasting impact of Covid to the long-term effects of other world events, such as the Industrial Revolution and both World Wars, noting that the people present at the time of those events could not imagine the global, long-term effects they would have.
“What did those parents (experiencing the beginning of the Industrial Revolution) tell their children about its long term impact on world economies?” Davis asked. Likewise, how are people now interpreting the financial impact of Covid?
Following Covid, “we will have a great rebalancing, as opposed to a return to the heady returns that have been seen in the last few years,” Davis said.
However, “persistently higher inflation will not be a legacy of Covid,” even though “inflation has not been as transitory as some had hoped,” he said. Inflation is at multi-decade high and will require central banks to act decisively to combat it, he added.
Innovation will play a key role in sustaining returns in the future, he said. “Covid accelerated innovation (especially in the) genetics and biomedicine areas,” he said. In addition, productivity in general will increase, “which is the real driver of rising returns.”
A good deal of the future of the economy depends on what happens with oil prices in the next few months, which is one of the primary forces affecting the rapid rise in commodity prices, he said. “If oil goes north of $150 a barrel, or even $200 a barrel, that will be close to a recessionary force. That will be a headwind for consumers,” Davis said. Oil prices depend largely on the financial impact of the Russion invasion of Ukraine, which is accompanying the human tragedy cuased by the war, he added.
Underpinning the other factors is a pent-up demand among consumers that could cause inflation to linger, he said.
In addition, “it is very likely that unemployment will continue to fall. By 2023 it could be less than 3%, which would be the lowest rate in history,” he said. “There has been an under-estimation in the tightness of the labor market.” Tight labor markets and strong wage pressures will dictate the pace of interest rate hikes by the Federal Reserve Board, he said.