It is two years since we wrote our April 2020 VFTD, titled Staying the Course, which recounted the epic polar adventure of Ernest Shackleton and his crew, aboard their ship ‘Endurance’. It was her sinking which proved to be the precursor to one of the most incredible stories of human triumph over adversity. Our message at the time drew parallels with the extraordinary resilience and collaboration shown by Shackleton and his men and the requirement for those same attributes to address the public health crisis, created by the emergence of COVID-19 and the sudden collapse in economic activity the world faced.
Recently, we have all been reminded of the remarkable Shackleton adventure, following the discovery of the wreck of Endurance on 5 March 2022, by an expedition team from the Falklands Maritime Heritage Trust. The ship has lain on the bed of an Antarctic sea, in near-perfect condition, for 107 years. In the fast-moving digital environment the majority of us now occupy, there is something quite mystical knowing there are parts of the world where time hardly passes; that a ship can sit in perfect cold and silence, undisturbed, for over a century.
Lessons from the past
Looking back through time and studying history can help us see patterns that might otherwise be invisible in the present. It helps us understand and grapple with complex questions and dilemmas, by examining how the past has shaped global, national, and local relationships between societies and people. No two periods are the same, but as investment managers, applying the principle history does not repeat itself, but it does rhyme can help guide us as we steward client capital through challenging environments.
Returning to Endurance, she slipped below the ice on her journey to the seabed on 21 November 1915. At that time, war was raging in Europe as the ‘Central Powers’ of Germany, Austria-Hungary, Bulgaria and the Ottoman Empire fought against Great Britain, France, Russia, Italy, Romania, Canada, Japan and the United States – known as the ‘Allied Powers’. As a consequence of new military technologies and the horrors of trench warfare, World War I saw unprecedented levels of carnage and destruction. By the time the war was over in 1918 and the Allied Powers claimed victory, more than 16 million people – soldiers and civilians alike – were dead.
Sadly – as many will know – this death toll is dwarfed by the number of deaths attributed to the influenza pandemic, which followed the end of the Great War. Evidence suggests 500 million people, or one-third of the world’s population, became infected with the virus. The number of deaths is estimated to be at least 50 million globally, with high mortality in healthy people, including those in the 20 to 40 year age group, being a unique feature.
With no vaccine to protect against the virus and no antibiotics to treat secondary bacterial infections, control efforts worldwide were limited to non-medical measures such as: isolation, quarantine, good personal hygiene, use of disinfectants, and limitations on public gatherings. Sound familiar?
What economic impact did the Great War, followed by a pandemic, have?
According to research undertaken by Goldman Sachs, the years leading up to the outbreak of war were characterised by relatively strong growth, partly fuelled by a rapid military expansion by European powers. Inflation accelerated sharply, from 1914 onwards, as the UK, Germany and France were forced to abandon the Gold Standard, rising to a peak of 50% year-on-year (yoy) in Germany and 25% yoy in the UK through 1917. The US joined the war in 1916 and growth and inflation both accelerated sharply in that year, with GDP rising 14% yoy and inflation reaching 17% yoy in 1917.
While growth and inflation both weakened during the subsequent pandemic, it is difficult to determine whether this was due to the war ending, or the pandemic. In economic terms, the battle against the virus was akin to fighting a war, with national resources deployed to fight an invisible enemy – driving government debt levels higher.
Based on their full study, which reviewed the macroeconomic impact of the 12 largest wars and pandemics through history – from the bubonic plague in the 14th century, through to World War II – Goldman conclude wars lead to higher inflation and higher bond yields.
So what can we expect this time, as we experience a pandemic, followed by a war?
Whilst wars are inflationary, the same research presents an argument pandemics are not. Any increase in government spending is used to fill the gap left by absent private sector demand, with very different implications for the overall balance between aggregate demand and supply. Additionally, pandemics do not result in any loss of physical capital. By way of contrast, wars result in debt-financed spending to fund reconstruction efforts (and rearmaments), driving aggregate demand higher relative to war-damaged supply.
All this seems logical, however, we know this current pandemic has proved inflationary. The extraordinary monetary and fiscal stimulus initiated by governments and central banks has resulted in too much money chasing too few goods. This lack of supply is also attributable to the pandemic – given the series of lockdowns economies have endured; and continue to endure in the context of China.
Furthermore, it is also important to recognise the war in Ukraine is not just a localised event. It has the potential to fundamentally reshape the global landscape. In some ways it already has: Germany is rearming, NATO has awakened and commodity prices are rising rapidly. All these factors are adding to inflation.
Fear of the enemy versus the trust in friends
Staying with our look through history, the strongest international orders of the past centuries have one constant: none of them were associations where all were welcome, and none of them pursued a higher goal to advance humanity. They were, first and foremost, alliances set up to thwart the main opponents. Put another way, international orders were largely built on fear of the enemy and not so much on the trust in friends.
The capitalist system, which has served as the engine of prosperity in the Western bloc since the onset of the Cold War, has increasingly revealed its shortcomings in recent decades. Ever since the 2008 Global Financial Crisis (GFC), it has appeared to many that Western capitalism is far from the ideological panacea it was promoted to be. Social mobility has decreased, debt has increased hugely, and oligopolies, if not monopolies, have arisen across various markets, undermining competition and concentrating enormous wealth with the few.
Implications for portfolios
Russia’s actions in Ukraine are abhorrent and symptomatic of a fragile international order, with a dysfunctional West, led by the US, squaring up to an extremely ambitious autocratic group of countries, spearheaded by China. As stated earlier, global geopolitical and economic landscapes are shifting and this will have consequences for financial markets over the coming years. Against this backdrop, the highly accommodative monetary policy framework, pursued across the major economies for the past decade and a half, is also shifting in direction.
There is no disguising the uncertainties lying ahead, but experience tells us investment opportunities will arise as a consequence: greed will give way to fear (or vice-versa); volatility will increase and asset prices will dislocate. De-globalisation is underway, and likely to accelerate, as governments introduce protectionist policies and companies increasingly prioritise security of supply over efficiency.
Whilst the above is for the future, right now, all eyes are on central banks – particularly the Fed – as they seek to tame inflation. Whether the problem can be parked at the door of the pandemic or the war in Ukraine – or even the central banks themselves – the tools available to address the issue, namely higher interest rates or quantitative tightening, are either limited or untested. Moreover, it will take time to establish whether they have been effective or not.
The majority of assets we manage as a business are done so within outcome orientated mandates seeking to deliver cash- or inflation-plus returns. The absolute level of this metric, whether it be UK, US or European-based – or its rate of change – have long been factors influencing our investment process.
Visibility over the near-term is clouded by uncertainty, but in much the same way Endurance appeared into view for those trying to find her, we are confident attractive investment opportunities will appear through the gloom.
Sources; Goldman Sachs Economic Research - Inflation in the Aftermath of Wars and Pandemics
ECR Research - various
Please do contact us with any questions.
