Even though it now feels distant, the year started out with a positive macroeconomic trend with indications for a recovery following a weak 2019. The comparatively positive start to the year then abruptly changed over to near panic in March. We saw an extreme drop in the stock markets in pace with the spread of Covid-19 to Europe and the USA. We also saw movements in the financial markets that were greater than what we saw during the financial and euro crises along with marketability that was very limited – or lacking entirely – for most securities. What we experienced in March with a long succession of days of market reactions can be most closely equated with what we had following the terrorist attack on 11 September 2001. To give an illustration of the scope of the stock market decline in March, the market capitalisation in the US stock market fell by nearly 11.000 billion dollars from top to bottom. This corresponds to nearly 50% of the USA’s annual GDP!
The political system has on the whole acted swiftly and resolutely in response to the pandemic. First came the imposition of various restrictions to slow the spread. These gradually grew very extensive in many countries in Europe and parts of the USA, with very large real economic consequences. To counter the negative consequences of the restrictions, central banks and governments began at an early stage deciding on various types of support measures. During the spring these monetary and finance policy programmes also grew increasingly extensive and are now at historically high levels; the fiscal policy stimulus measures alone are expected to amount to a whopping 15% of GDP as an international average in total over this and next year.
Owing to a combination of strong support and stimulus measures, gradually improved control over spread of the disease, gradually improved knowledge about Covid-19 in general and the successive easing of restrictions, since early April the financial markets have recovered considerably. Now at mid-year, looking at the combined changes in asset prices since the start of the year, they are in many cases astoundingly small given the extreme period we have endured.
The scope of the impact on the real economy during the first half of 2020 has been brutal. The speed and depth of the economic slowdown far exceeds what we saw during the financial crisis. For 2020, GDP is expected to fall in the range of -8% in Europe and the USA compared to what was expected before the pandemic. Following such an historically dramatic slowdown, it is natural that we will have a rebound in 2021, but according to our main scenario we do not believe that we will be back to the same GDP level as before the pandemic struck until around 2023.
A historically large drop in GDP this year and thereafter a rebound in 2021 notwithstanding, the long-term key question is whether the pandemic will cause structural and permanent damage to the world economy, and if so, how much. Revolving around this question, undoubtedly there is no lack of areas of concern, including the risk for permanently high unemployment, a new crisis in the financial system, a halt to globalisation and increased regional tensions, and a sharply higher level of debt that may lead to structural problems in the future. On the other side of the scale, and more positively, are other factors that over time may strengthen the economy’s way of functioning and productivity. Examples of such factors are an acceleration of digitalisation, investments in neglected infrastructure, the shift to a sustainable society, and the potential for positive structural reforms.
Ultimately much will be determined by whether the resources that will be invested into restarting the world’s economies succeed in steering towards long-term productivity improvements and that the leading economies have the continued resilience to embrace the belief in the benefit of global cooperation and global economic collaboration. Our current assessment is that the pandemic will certainly lead to permanent damage to the world economy, but that this damage will not necessarily be as hard to repair over the long term as after the financial crisis. The financial crisis entailed a meltdown of the world’s banking system, with an essentially broken credit system for a long period of time. In Europe the crisis in the banking system subsequently gave way – through very strained state budgets – to a deep and paralysing euro crisis which parts of Europe have still not recovered from. The situation is very hard to predict however, and it is certainly possible to conjure especially more negative scenarios, but also some that are more positive.
In the type of extraordinary markets that we saw in March and April, AP4’s asset management has moved in to what we call a state of readiness, since the external conditions require a different focus and set of dynamics than AP4’s ordinary processes. A state of readiness entails, among other things, a considerably higher meeting frequency than normal – and flexible, specially adapted meeting constellations suited for this purpose – to ensure effective information-sharing, a cohesive grasp of the Fund’s larger positions and focus on swiftly acting on business opportunities. In short, our state of readiness during the spring has involved maintaining full focus on the following main principles:
• Avoid forced trades in non-functioning markets – trade only when it is necessary and then underpinned by an investment analysis
• Dare to be long-term (one of the Fund’s unique characteristics) – hold, and even increase, positions that we believe in longterm and act as a long-term and responsible owner
• Strive to take the offensive – seek out and take advantage of opportunities and imbalances that emerge in the market
• Support each other – stay positive and keep calm
Such a difficult, disorderly and nervous market that we have had during the spring entails challenges, but also opportunities, for a long-term investor like AP4. For example, we began buying equities after the first, major initial drops to maintain our asset allocation. Another example is corporate bonds, the price of which fell indiscriminately in March, when the market in its hysteria could not manage to differentiate between various companies. Here we saw an opportunity as a long-term investor to increase our investments in corporate bonds issued by quality companies that structurally benefit – or at least are not put to a disadvantage – from the long-term impacts of the Covid-19 crisis.
We have also acted as a long-term and responsible owner in this extremely difficult and uncertain situation. This has been done, among other ways, by engaging in proactive dialogues with companies and with owner groupings on companies’ need for capital, which has resulted in AP4’s participation in several new share issues to support companies with sound long-term models. AP4 is also contributing to the establishment of an investment company together with AMF, FAM,SEB and AFA Försäkring, whose purpose is to work in the prevailing, difficult market situation by injecting capital and serve as a minority owner in supporting primarily unlisted, medium-sized Swedish companies that have business models that will remain sound after the pandemic. It is also gratifying that a proposal for a temporary change in legislation that will allow the AP Funds to own up to a 15% voting stake in listed companies (it is currently limited to 10%) has been circulated for review.
AP4 reports a return of -2.5% for the first half of 2020. The main explanation for the negative return is AP4’s substantial holdings of Swedish and global equities. But even real assets thus far this year have had negative returns, while fixed income assets have made a positive contribution. A negative result never feels satisfactory, but given the circumstances, our return for the first half of the year can still be regarded as a passing grade for how we have managed to deal with the spring’s market turbulence. The entire organisation has worked very resolutely and professionally throughout this difficult time.
In closing I want to direct great thanks to all of AP4’s employees for how well you handled the work burden during the spring. The management and handling of AP4’s portfolio have been conducted in a superb manner at the same time that our operations continued to develop with the goal over time to optimally perform the Fund’s assignment to generate a long-term favourable return for today’s and tomorrow’s pensioners.