For many reasons, most people’s eyes were not on the world of finance the last two or three quarters. This does not apply to investors and analysts — who are well aware of 2020’s mighty bull market. As always, predictions were commonplace around December. Surely the financial sector cannot remain an enclave of peace and prosperity in the midst of unravelling economies for long. Indeed, the challenges and opportunities of 2021 rest on phenomena and policies initiated in 2020 — as will be shown. Still, as of now, what lies ahead is much less certain than some analysts seem to believe.
It is worthwhile to make a roundup of what is to expect in the next months. The main upcoming challenges are: 1) a boom in non-performing loans (NPLs) and 2) a possible inflation spike. The continuation of the bull market is a risk that may turn into an opportunity to reap.
NPLs are Behind the Curve
In economic and banking jargon, a loan becomes “non-performing” when it meets specific conditions. According to the International Monetary Fund a loan becomes an NPL when:
- There are at least 90 days of unpaid instalments and/or interests;
- “[I]nterest payments equal to 90 days or more have been capitalized, refinanced, or delayed by agreement”;
- The creditor has “other good reasons […] to doubt that payments will be made in full.”
Empirically, an NPL is a loss for the creditor in most cases. As 2020 ended, debtors around the developed world manage to hold on to their obligations thanks to public aid. Yet, “bankruptcies and debt defaults will rise sharply in 2021 as […] government financing and forbearance programmes reach an end.” NPLs are already ballooning in weaker economies like the Philippines, Kenya and India. Meanwhile, the EU already acknowledges them as problematic. And figures in the US and China are equally worrying.
True, “NPLs may become performing again after some time.” But this is a risky bet. Currently, it is much more likely for performing loans to become NPL than for NPLs to perform again. In this sense, between the NPLs of the Great Recession and these new NPLs there is a difference in substance. The former mostly overlapped with “NINJA” loans — i.e., loans to households with No Income, No Job or Assets. Most of the time, banks never fully collected these debts because they are unguaranteed and the debtor has no collateral. In contrast, the new loans usually turn into NPL because the creditor has lost his source of income due to anti-pandemic policies. Either way, no short-term fix seems to yet be in the workings.
Inflation: “Not enough” may become “Too Much”
A concern that shadows the hopes of investors with portfolios of all sizes is a resurgence of inflation. Central banks’ stated predisposition towards forbearance of higher-than-targeted rates of price growth in the US and Europe is a worrying factor. At the same time, so-called bottlenecks on the supply side may lead to an overheating of the economy.
A bottleneck is a point of congestion in a production system (such as an assembly line or a computer network) that occurs when workloads arrive too quickly for the production process to handle.
One can interpret growing savings rates across major economies as repressed demand or a form of forced savings. This phenomenon was widespread in fixed-price economies such as the USSR, where it then resulted in sustained hyperinflation. Once the external constraint forcing people to save more – i.e., anti-contagion policies – drops, money could pour in. The result would be an unprecedented rise in inflation well beyond the 2% target the ECB and the Fed pursue.
However, according to the rosiest predictions the “bout of inflation” will probably be “temporary”. In fact, the real economy is underperforming as shown by the huge estimated output gaps. This means that after a short shock, productive capabilities will align to the level of aggregated demand, removing excess inflation. In the meantime, inflation will interact with the markets and “boost equity prices, not retard them.”
Too High, Too Fast… Yet it Doesn’t Stop
As mentioned, 2020 has been an incredibly positive year for stock markets around the globe. Also, it was also the year in which every analyst seemed to repeat a mantra on this point. In the past year, the phrase the stock market is not the economy was uttered thousands of times. Criticisms came from both sides of the ideological spectrum. Yet, 2020 ended on a bright note thanks to marginal phenomena such as “Robinhood trading”. Through these ‘gamifying’ investment platforms, people left at home by shutdowns could access the stock market and reap some benefits. The fashion behind ‘Robinhood’ investors has expanded beyond the US, reaching as far as India.
Nevertheless, the trickle down is not working. A Nobel-prize laureate noted that “[o]ptimism about Apple’s future profits won’t pay this month’s rent.” While stocks are soaring, the real economy is suffering and the middle class is sinking in poorness. Despite this contradiction, stock exchanges seemed set on a steadily-rising course and performed strongly in 2020. This was the case for two reasons.
The fact that recession has hurt small unlisted businesses more than large listed firms is one part of the story. The other is the paucity of yields on offer from bonds.
For this to continue in 2021, there are some preconditions. First, governments’ and central banks’ policies should keep supporting economy activities — which is not likely despite OECD’s suggestions. Second, inflation has to remain a far-away dream — or nightmare. Finally, the debt burden discussed above should not drag on companies’ finances. In the words of a professional broker: “the longest this bubble might survive is the late spring or early summer.”
Fabio A. Telarico was born in Naples, Southern Italy. He is fluent in Italian, English and Bulgarian. Between 2015 and 2017 he won several prizes in nation-wide literary contests. Since 2018 he has been publishing on websites and magazines about the culture, society and politics of South Eastern Europe and the former USSR. He also participates regularly to international conferences on the same topic.
This article was first published in Global Risk Insights
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