In my opinion, the answer to the question above is “less than most people expect.” I think life will return to “normal” in ways that may be hard to imagine amid worries about the Delta variant. Early in the pandemic, my colleague Eunhak Bae wrote the following about living through 9/11 in New York City: “In the immediate aftermath, it seemed like no one would ever fly on a plane again. That obviously turned out not to be true. Today, it may feel like the world has changed for good. But I believe humans are blessed with selective memories and a desire to revert to what they know, so people will once more buy things, go see things, and congregate to share experiences.” When I first read those words, I thought the reversion to normal would happen much more quickly than it did, but I still think that’s our destination, perhaps within the next six – 12 months.
Why inflation will be an exception
The big change I foresee is in inflation, which has been unusually low for an extended time (1.4% over the decade ended December 2021 and 1.6% for the trailing 15 years). We have seen in past crises that economic stimulus tends to be harder to remove than people expect. (Recall that the first rate hikes after the 2008 global financial crisis (GFC) didn’t come until the end of 2015.) While the need for stimulus suggests an economy that is too weak to exhibit inflation, I believe the substantial fiscal stimulus that accompanied monetary easing in 2020 will follow a similar pattern of a slow unwinding, and this will be at least modestly inflationary.
More broadly, there are reasons to expect the inflation picture post-COVID to be different from the aftermath of the GFC. After 2008, governments were focused on austerity (e.g., the US Tea Party movement) and businesses and households were focused on balance-sheet rebuilding, especially homeowners whose largest asset had often fallen sharply in value. Today, governments are focused on spending (e.g., US infrastructure plans); businesses are in reasonably good shape given low rates, tight spreads, and government support; and household balance sheets have been bolstered by government aid and a year of reduced discretionary spending.
In addition, while I acknowledge the wide range of potential political outcomes, I believe the increased sensitivity to income and wealth inequality that emerged during the pandemic is another change that is here to stay. All else equal, a narrowing income and wealth gap is inflationary because more money goes into the bank accounts of people with a higher marginal propensity to spend it. Finally, inflation is likely the path of least resistance for managing the massive government debt post-COVID. (Debt growth itself represents a COVID-induced economic change, but not one I expect to have a meaningful impact beyond prospective inflation.)
Many pre-COVID trends will continue
I would include in this category the rise of China (and related geopolitical tensions); concerns about the economic impact of global warming; and accelerating technological innovation in a range of areas, including automobiles, cloud computing, and online retail (advances in the latter were doubtless hastened by COVID.)
In many industries, the ability to work from home and remain productive is a COVID-induced shift whose effects I expect will endure, but I don’t see this having a meaningful impact on economic growth or markets. (This evolution could arguably change demand for commercial real estate, but I think when all is said and done, the “normalized” state of the world will be much closer to pre-COVID life. Our real estate team expects a renewed “suburbanization” as millennials leave big central cities, but I would argue this is a trend that was underway pre-COVID and had its roots in demographics.)
Why this view could be wrong
I can think of at least two big risks to this view. The first is that COVID continues to race (read: mutate) ahead of medical technology and we end up in a world where things we took for granted pre-COVID (large gatherings, travel) are no longer viable. The second is that the world fails to find a way to vaccinate a substantial fraction of its population (perhaps especially in emerging markets), in which case I believe the economic and geopolitical fallout could be dramatic, to say nothing of the human toll.
Those risks aside, from an investor’s perspective, I believe inflation is the most important area to monitor. We have written several papers addressing inflation risk from different angles and offering suggestions on how to manage a portfolio through inflation. Investors can also seek to take advantage of trends that COVID has accelerated, but I would argue for complementing these with “return to normal” trades that reflect what feels like a non-consensus view that the long-term impact of COVID may be surprisingly modest.