Niall Ferguson: We’re Still Early Into This Crisis

The economic historian offers a playbook for investors to navigate the pandemic.

Niall Ferguson (photo by Dewald Aukema)

Niall Ferguson

(photo by Dewald Aukema)

“The pandemic has morphed into an economic crisis far greater than the Great Recession of 2008,” says economic historian Niall Ferguson, “because major Western governments’ response to the coronavirus was late, especially in the U.S. where cases have now topped one million and deaths have now well exceeded those of the Vietnam War.”

China committed the original sin of allowing the virus to spread unchecked across the rest of the world for weeks after Chinese doctors realized how dangerous it was.

But virtually all Western nations also messed up by closing their eyes to the invisible threat that was crossing their borders.

Just as the outbreak was underway at the beginning of January, Mr. Ferguson was traveling across eastern Asia, giving lectures in Hong Kong, Taipei, and Singapore. Having learned what was going on in China’s Hubei Province, he warned attendees at Davos that it was an impending pandemic, not global warming, they should be worried about.

This wasn’t new territory for Mr. Ferguson. Through his book, The Square and the Tower (2018), and related PBS series Networld (which recently aired), he described the role of social networks and contagion in history and warned of the risks of the world’s intensifying interconnectedness—well before the Coronavirus struck.

He gave the same message to 27 leading asset managers and high-net worth clients who enlist his advisory firm, Greenmantle, for macroeconomic and political guidance. He warned them in late January 2020 that equity markets would likely be severely impacted once the potential of the virus was known. He also foresaw a U.S. recession. Those who heeded his advice and moved from equities into short-term Treasurys were well rewarded.

Because the U.S., like much of the developed and emerging world, has been so slow to respond to the pandemic, Mr. Ferguson believes selling into rallies still makes sense.

“We’re still relatively early into this crisis,” he cautions, “and despite all the monetary and fiscal policy being thrown at the problem, addressing the spread itself is key to containing the financial fall out.” He fears if countries continue to mishandle the public health crisis, it will only exacerbate the pain later on.

“This is everyone’s Chernobyl,” says Ferguson, referring to the infamous nuclear reactor’s northern Ukrainian hometown of Pripyat, which is now a ghost village.

Mr. Ferguson has hunkered down with his family in Montana, where, he says, consistent social distancing is far easier than in the Bay Area, where they usually live.

He took time to speak with RIA Intel about the direct and indirect financial consequences of the crisis and what investors and countries can do to help mitigate the fall out.

Broadly speaking, how do you think the economy will fare in 2020?

The IMF just projected the U.S. economy would contract by -5.9% in 2020. That’s assuming lockdowns are over in the 2nd quarter and a recovery in the second half. My expectation is not for a V-shaped recovery. I anticipate the U.S. will be hit by a second wave of C-19, which will inhibit recovery. As soon as you kind of drop your guard, this thing will come back. It’s hard to resume any kind of normal economic life without people crowding together. Given that risk, social distancing will have to continue, which will limit consumer demand. That said, there’s a substantial part of the economy that can function with social distancing, including big-ticket items like manufacturing and construction.

What were financial markets telling you as April ended?

Right now financial markets are sending false signals about the likely trajectory of the real economy and that’s because they are still responding to massive government relief programs, which for the time being, have prevented financial assets from cratering the way they did in 2008.

The real economy has been hit far harder by Covid-19 than by the financial crisis of 2008-2009. The Fed and the Treasury have built floors not just under equity prices, but beneath other asset classes, including non-investment-rated bonds. But this is an unsustainable state of affairs.

Are we responding to the current crisis like we did in 2008 or are we making necessary adjustments?

We’re seeing a similar response that was made in 2008, but on steroids. Yet, it’s not clear if the people managing the crisis understand that this is a pandemic first, a financial crisis second. We won’t be able to bring the economy back until we get a handle on the public health crisis. And the President’s daily press briefings did not make it clear that it’s not just one curve we have to bend. There will be other curves, unless this pandemic is completely unique in history. Fiscal and monetary measures only bought us a small amount of time. Soon businesses will begin to die if there isn’t a return to work in the next few weeks.

What would you advise President Trump?

We need more reliable testing and a system of contact tracing so that when there’s a return to work we’ll be ready for the game of “Whack-A-Mole,” which we’ll be playing until a vaccine is found and effectively rolled out. Until we get adequate testing and contact tracing, it will be like playing “Whack-A-Mole” in the dark. And this is likely what’s going to happen in the states that are opening now. So they can expect excess mortality rates to be much higher than say in Austria or Germany, where they are beginning to reopen more methodically.

What does all this mean for markets and investing?

In addition to the damage caused by the Russians’ and Saudis’ ill-judged oil price war, the oil markets are showing there has been a massive economic contraction the world over. My sense is that equities haven’t yet bottomed and the rally that started in March in response to government intervention will likely fade.

Did it surprise you that the Fed is purchasing junk bonds?

Yes. I don’t understand the rationale behind that. I think it’s more a declaration of intent rather than something that’s been put into action. Still, historians will look back at this and ask, “Why on earth was this even proposed?”

Which equities should hold up and which will likely remain vulnerable?

Big companies generating steady cash flow like Microsoft and Amazon will see their value enhanced given the risk-free rate of interest is basically zero. These companies are worth more in late April than they were at the beginning of the year. And in a post-Covid-19 world, I can’t see what could stop these firms from making money and rallying further in 2021 and 2022.

On the other hand, companies that depend on large-scale movements of people like airlines, UBER and Air B&B look to be in a very bad place until the fear of close interaction is mitigated by a vaccine and therapies that work.

Finally, I think the explosion of monetary and fiscal policy would make gold an attractive commodity to hold, and I’ve not been surprised to see it rally.

How will the crisis and response ultimately effect the economy?

The short answer is either you have a period of austerity ahead of us as we try to get the deficit back under control or there’s some inflationary risk in store. It’s hard to see a third option between these two.

Are there compelling investments in countries where they’ve handled the crisis significantly better than we have?

I think we’ll see attractive opportunities in Asian markets, such as Taiwan, Singapore, and South Korea, where they got the virus under control marvelously well. So one has to feel relatively bullish about the prospects of such economies. Specifically, I think compelling stocks include semi-conductor companies like Taiwan Semiconductor Manufacturing Company and Samsung. The last few months have been a great advertisement for those countries.

Do you think these tech companies can thrive in spite of the major global slowdown?

Only in relative terms. But it’s interesting to see that big tech companies like Microsoft, Apple, and Amazon have sustained market capitalization far better than those in other industries. And those companies can’t thrive if there is an interruption to the supply of high-performing semiconductors. Software without hardware is useless, and hardware is absolutely dependent on the increasing capacity of semi-conductors. East Asian companies are critical to that supply.

Moreover, the world will become more virtual post-pandemic. We’re going to do more online—whether it’s replacing business trips with Zoom meetings or trips to the cinema with Netflix—and that’s all predicated on the internet having the capacity to cope with this rising demand. And that’s why I think the big hardware companies in East Asia will be likely winners to help meet increasing bandwidth.

If China’s Huawei doesn’t remain the lead supplier of 5G networks because of the breakdown of the west’s relations with China, who will take its place?

There are two European competitors—Nokia and Ericsson. But Huawei can offer cheaper hardware with cheaper financing. The interesting question is does the U.S. have the capacity to catch up in this space and to lead the way in 6G?

When the pandemic is over, the tech war will continue. It was actually always more important than the trade war. The U.S. is hamstrung because it doesn’t have a home-grown 5G solution to compete with Huawei, and it doesn’t have a digital payment solution to compete with Alipay and WeChat Pay, which are rapidly growing around the world. They are handling far more transactions than any western equivalents. This is the frontier that really matters.

Are we printing money that could trigger serious inflation?

The U.S. is printing money, but it’s doing so by creating excess reserves, not regular money. To be clear, these are interest-bearing reserves that banks are holding. And that’s different from what happened in the Weimar Republic after the First World War. And yes, this will mitigate the risk of inflation. But there’s definitely a scenario you can imagine where, maybe several years from now, there will be inflationary pressure from constrained supply and plentiful money. But that’s not the biggest worry that we face right now.

The more likely worry is that we’ll need to figure out a way to pay down a huge national debt through tax increases or spending cuts. I think future austerity and the impact that will have on growth is the much more troubling concern.

Are we at risk of seeing large financial institutions fail?

The posture of major governments is to prevent such failures, especially after seeing the effects of Lehman Brothers’ collapse. Banks went into this crisis better capitalized than they were in 2008. But I don’t expect bank failures because since the last financial crisis, banks have been implicitly underwritten by their respective governments.

Are we likely to see another sovereign debt crisis like the one that followed the Great Recession?

A whole bunch of countries are going to default. Argentina, Ecuador, and other emerging market countries will lobby for debt forgiveness, and the IMF and World Bank will give them that to a certain extent. Private creditors will be less indulgent.

Developed countries won’t default. The European Union and Euro Area are already acknowledging what will likely be necessary to prevent a repeat of the sovereign debt crisis of 2011 and 2012. They will just raise a lot more debt, and the European Central Bank will backstop it. The fear then is that these countries could end up like Japan, where stagnation has been the norm for a long time.

My forecast is for really slow growth because, one, the steps governments will need to take to contend with their soaring debts (tax increases and or austerity) and, two, I think consumers may tend to save more once out of this crisis as a precautionary response, and that will be another headwind for growth.

Niall Ferguson is the Milbank Family senior fellow at the Hoover Institution, Stanford University, and managing director of the investment advisory firm Greenmantle.

Eric Uhlfelder has covered global capital markets for 25 years, wrote the first book on the advent of the euro post currency unification, and has earned a National Press Club award.