Is KYC necessary to create a draft demand
Like many investors, we are thinking about the possible long-term effects of the COVID-19 crisis. It's early days, of course, but we believe that the aftermath of the pandemic could transform the relationship between companies, their stakeholders and the government in ways that could have significant long-term consequences for stock investors.
In this article, we look at two aspects of this topic: ESG and the realignment of stakeholder interests, and stimulus measures and the likelihood of higher taxes and inflated sovereign debt.
ESG and the realignment of stakeholder interests
Since the first coronavirus outbreak, many companies have made efforts to help their employees and customers who are particularly vulnerable to the financial and health risks associated with COVID-19. This has often resulted in actions that benefit stakeholders (including employees and society at large) rather than shareholders in the short term. However, it is unclear to what extent this development will last.
These measures include dividend cuts and share buybacks. This reverses the trend from the time after the financial crisis, which was accompanied by increasing payout ratios and buybacks. These were often financed by issuing corporate bonds, especially in the US. Higher dividends and buybacks went to the benefit of the capital owners, who were able to increase their earnings considerably as a result. In addition, over the past 20 years, a growing proportion of companies in the S&P 500 have linked CEO salaries to shareholder returns.
Given the global pandemic, companies are cutting their dividends as well as their buyback programs. At the same time, they strive to help their customers and employees. For example, UK real estate company Rightmove announced a significant cut in the fees it charges from independent real estate and rental agents. The banks announced the postponement of principal payments, and US auto insurers have agreed to reimburse part of the surplus profits resulting from the lower accident rate due to lower mileage during the crisis. A leading European luxury goods company manufactures hand sanitizer in its perfume factories and plans to sell 40 million face masks.
In emerging markets, companies are taking similar steps to support their communities, employees and business partners. Shortly after the pandemic began, a leading Chinese restaurant chain provided rescue workers with free meals and introduced health insurance for all restaurant managers in Wuhan Province, China, where the virus first appeared. To meet the demand for personal protective equipment for medical workers, a Belarus-based digital design company developed a surgical mask that can be 3D printed. The design and manufacturing instructions are free. In Brazil, a large retailer offered various types of support to its suppliers, including: extended credit lines and help with access to market finance.
Even before COVID-19, there was an increasing sense of social responsibility among companies, which is likely to gain importance as a differentiating factor in the crisis. Once the crisis is over, this factor may subside a little, but we don't think it will go away entirely. In this respect, the more stakeholder-friendly companies, especially in Europe, could lead to reduced profitability and lower dividend payouts. On the other hand, companies that can be “part of the solution” (for example in technology, healthcare and banking) now have the opportunity to improve their standing with regulators and society.
Financial incentives, higher taxes and public debt
As most countries in the world have put together unprecedented fiscal and monetary stimulus packages to mitigate the shock of the corona-induced lockdown, budget deficits and national debt are expected to rise significantly. The higher spending on health care and social systems could exacerbate this effect. Therefore, taxes may need to be increased to fund these aid programs.
The fiscal incentives announced so far already far exceed the measures taken during the global financial crisis of 2008–2009 (illustration 1). If governments raise taxes to keep budget deficits from spiraling out of control, we expect wealthier households to account for a larger share of national tax revenue. At the political level, important decisions could be made about the relationship between direct and indirect taxes (income tax is a direct tax while sales tax is an indirect tax) and the taxation of labor or capital. Will existing tax breaks be canceled? Will new taxes be introduced? These are some of the questions that will affect corporate profits and the stock markets.
The announced stimulus packages go far beyond the measures taken during the global financial crisis
FIGURE 1: CHANGE IN CYCLE-ADJUSTED PRIMARY BALANCE AS PERCENTAGE OF GLOBAL GDP
Source: CBO, European Commission, Haver, UBS; Data as of June 2020.
It is too early to speculate about how specific policy choices will affect industries and companies, but they could have far-reaching consequences. The upcoming US elections add additional uncertainty: a Democratic march could result in a corporate tax rate hike to fund recent stimulus packages. This would likely weigh on some of the more domestically oriented businesses that have benefited significantly from the 2018 tax reform. However, we believe the effect would be fairly broadly distributed.
The increased incentives went hand in hand with much higher government bond issuance, another factor that will impact the corporate landscape. The growing debt burden suggests that the risk of unsustainable sovereign debt and sovereign defaults is likely to increase significantly in many countries. For example, South Africa's debt, which recently lost its investment grade status, is likely to soon surpass the 80% of GDP mark that is often viewed as a trigger for a sovereign debt crisis in emerging markets.
In our view, the COVID-19 crisis has the potential to transform relationships between businesses, their stakeholders, and the government in ways that could have subtle but meaningful long-term consequences. This applies in particular to regulation and the freedom to use capital. We also believe that government incentives, while welcome in the short term, could lead to higher taxes in the long term, with unpredictable effects on businesses. We keep an eye on all of these risks as we analyze companies and sectors across the global economy.
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