II pillar

The largest international securities markets were relatively calm in September. The North American and Western European stock markets lost a small part of their summer gains during the month, while the value of Japanese listed companies even rose slightly.

After a major shock in the first half of the year, the markets have generally behaved as if nothing had happened: stock markets have stabilised at a slightly lower level and the feared wave of insolvency is still not evident almost anywhere in the world. However, no one seems to doubt that the pandemic that erupted at the beginning of the year will have serious and long-term economic consequences in the future.

As with any major change, there are winners and losers in the economic crisis caused by the COVID-19 virus. One thing is clear: the world’s economic pie will be smaller in the coming years than it would have been without the health crisis, and the recipe for how this pie is baked is likely to change over time.

Governments have spent much more than their declining tax revenues would have allowed. In addition, central banks that have defended conservative fiscal policies in the past (at least in words) have changed their minds and are encouraging governments to spend more vigorously by opening their vaults and offering them money-printing machines. An extraordinary situation requires extraordinary measures.

It is dangerous to lose sight of the lighthouse after a storm and drift close to the reefs in the confusion. When a company loses a market or a person loses a job, it is a big shock to them. When lost income is replaced with a loan, problems can be ignored for some time, but it is more sensible to consider all possible future scenarios and prepare for change, rather than burn out the existing but declining capital. Strength – capital – should be kept in case the storm lasts longer than initially thought.

Each coin has two sides

It is no surprise to readers of the monthly LHV pension newsletter that the main risk factor in my economic model is the debt level. By taking on debt in a stable economic environment, it is possible to accelerate economic development, just as it is possible to move faster at sea by using a larger sail with a calm wind. On the other hand, manoeuvring is easier with a smaller sail.

However, if you overestimate your abilities (whether as a seafarer or a businessman) and choose a sail size or debt burden that doesn’t match your skills, an unexpected or larger change in the external environment can have tragic consequences. The rule of thumb is that if the wind speed increases, it is worth reducing the surface of the sail – in a stormy sea, a smaller sail can move even faster. Similarly, in the case of inflated debt, investments need to be made even more wisely than usual, taking care that they do not become an additional burden in the future.

Debt has risen almost everywhere in the world in an era of slow economic growth and low interest rates (graph). By the end of the first quarter of this year, the total debt in the world economy had reached 220 trillion euros, which is 330% of the world’s gross domestic product.

Those who don’t think about tomorrow believe that interest rates will not rise any time soon (or perhaps ever), or else a large part of the economy would become insolvent. However, those who doubt the success of redistribution and planned economy, and instead believe in the logic of the market, know that greater risks should come with greater returns (and not the other way around). The trend in recent years has been that interest expenses decrease as the debt burden increases, but it is dangerous to extrapolate this trend to the future.

At a time when the clouds over the global economy are darkening, we have managed the LHV pension fund portfolios, first, by choosing investments in which we have more control over risk (debt) management, and second, by choosing investments that are highly liquid.

In recent months, we have gradually reduced our equity position, which increased during the sharp decline in the stock market in the spring. For example, in September, we sold our positions in the e-commerce companies MercadoLibre and Alibaba after their powerful rise.

At the same time, we have increased investments in gold miners precisely because, in an unstable economic environment, gold is regaining its position in investors’ portfolios, offering protection against the consequences of unconventional fiscal and monetary policies.

Just as the medical effects of COVID-19 are more severe among overweight people, the countries, businesses and people that use credit thoughtlessly are at risk in every economic crisis. There are now even more risks in the financial markets than before the coronavirus crisis, but our task remains the same: to choose the right tactics and find the way to the best possible return without major shocks.