Fidelity: Not business as usual

Key points

• We see some new headwinds emerging for companies when the global economy reopens following the coronavirus outbreak.
• For example, as governments deploy large stimulus packages it is likely that effective tax rates for companies won’t continue to fall and may increase.
• Regulation and wage pressures will also emerge, particularly in the US but investors should consider how this will play out globally.

Although we have seen unprecedented economic disruption over recent weeks, it is worth taking a step back to think about a return to normal, or what ‘business as usual’ will look like. There are certainly reasons for investors to be optimistic - fundamental value has emerged across debt and equity markets but it is worth exploring some areas where new headwinds to corporate earnings growth could emerge.

Taxing times

The first area is corporate taxation. Over recent decades we have seen effective tax rates fall for companies globally, with arguably the most meaningful shifts happening in the US and Europe due to the direction of fiscal policy and the rise of the knowledge economy. As governments deploy large stimulus packages in the wake of the current pandemic, it is likely that this trend will cease - and possibly reverse.

There will be a growing political sensitivity to those parts of the economy that are seen to be the beneficiaries of government intervention. Recent experiences such as in the US, where we saw that the cuts in corporate taxation announced in 2017 were in large part used to fund share repurchase programmes, are likely to become more controversial.

Regulatory reaction

Second, it is likely that sectors which have seen a light regulatory touch over recent years could face more scrutiny to ensure that they are delivering appropriate value to customers and society more broadly.

In many cases, such as online platforms, new businesses models have scaled up and disrupted prior incumbents at speeds that left many regulatory bodies unable to keep pace. A decade on, many of these businesses are now dominant in their sectors. In some cases, they could face the double whammy of slowing growth and tighter regulation (whether that be around data privacy, content quality or the ‘responsibility’ of the underlying algorithms).

The shifting jobs market

Third, despite an extended period of economic expansion and historically low levels of unemployment, we have seen prices in the real economy (reported inflation) and real wage growth remain sluggish. Explanations for this include the low labour force participation rate and a mix shift in the nature of work.

If we do see greater government spending on key sectors such as healthcare, infrastructure and other core services - where historic underinvestment has been made most visible by the Covid-19 pandemic - this could coincide with less ‘spare capacity’ in the economy, putting upward pressure on wage growth.

This would be good news for the economy overall, but many companies have not had to contend with these pressures. Partly as a result, despite modest activity, many companies have been reporting cyclically high levels of profitability. So, looking ahead, even as demand picks-up we may see less operational gearing than we have at previous turning points.

Key takeaways

Taxation, regulation and wage pressures will be most acutely felt in the US corporate sector, but for investors it is worth considering how these factors will play out for all economies and regions where greater government spending becomes the dominant economic strategy. While policy intervention will help to mitigate the near- and medium-term pressures on the global economy, it will inevitably come with some costs.

Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. Reference in this article to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only.