“The economic cure to the disruption of Covid-19 will not be resurrecting yesterday’s economy,” think Goldman Sachs. Instead, the Wall Street bank believes the answer lies in “retooling” failing companies, replacing those that cannot change, and letting the winners consolidate and expand.
This somewhat Darwinian framework is the starting point for a recent thought-piece on the pandemic, which authors Steve Strongin and Deborah Mirabal call ‘The Great Reset’. Over 11 pages, and without mentioning a single specific stock, the report sketches out Goldman’s thoughts on how investors should approach “the business and investing landscape post-Covid-19”, without specifying how or when that all-important period is likely to begin.
In fact, the missive gives the impression that, amid the economic and corporate debris around them, investors already have half a foot in a “post-Covid-19” world. For a start, the primary phase that Goldman identifies is preservation, during which time uncertainty forces companies to focus only on the immediate concerns of funding and balance sheet repair. This won’t be news to many stock-pickers in June 2020, although Goldman suggests that this period is likely to see plenty of misallocated or wasted capital.
It is the two stages that follow – consolidation and innovation – that are of greater interest.
The former does not strictly refer to consolidation in the M&A-sense, despite what you might expect of an investment bank. Moreover, Goldman refers to the way sectors and markets will reshape around business models that are more or less functioning in the pandemic-struck economy. Typically, this will involve customers and businesses relying on solutions that they know work, which in turn reduces the need for both capital flows and physical investment. The authors’ point here is that companies making money in the current environment have a good chance to take market share.
The third stage for investors to navigate is more nuanced. Here, “business problems will have changed in a deeply substantive way and thus the need for and the potential value of new solutions will be high”, Strongin and Mirabal argue. While the consolidation phase allowed some companies to thrive as a matter of circumstance, competitive advantage will shift toward disruptive technologies and business models able to tap the “significant capital” on standby. The accelerated change brought on by Covid-19, Goldman suggests, should reduce the heavy costs normally associated with disruption.
Alongside these sequential developments, the report urges investors to focus on four themes affecting businesses and investing.
First is a fresh appreciation for resiliency, and for business models that are reliable under stress rather than being simply the most cost-competitive. Goldman does not think this will result in “local-only” supply chains – which it reckons would be too expensive and fragile – but rather an efficient mixture of “local and global” systems with inbuilt redundancy. The report suggests this will result in a broad mix of new entrants and “lucky” consolidating winners, some of whom may “simply try to use their temporary advantage for short-term gains”.
Second is the steep learning curve many companies find themselves on. Not all of the many changes currently taking place will be permanent. But changes that once might have needed decades to embed could now arrive in just a few years. To Goldman, this will erode what markets often assume to be first-mover or early-adopter advantage, and cites the example of deposit-focused wealth or saving platforms – focused on a high income, newly tech-savvy older client base – as having potentially taken the edge over once-hyped online lending platforms catering to younger borrowers.
The dynamic is arguably more profound within companies, which the report notes have “been forced to experiment massively with work processes, including work from home, tele-everything, rapid cloud adoption, new supply chains, new distribution channels and new global alliances”. Much of what we previously understood to be managerial or corporate control, Goldman argues, has been shown to be an illusion.
Third is what the authors describe as “risk-based segmentation”, or in simpler terms, the way customer habits and groups are set to change. The uncertainty created by the pandemic is likely to lead to complex social shifts in the kinds of risk people are prepared to take. These behaviours may not be as straightforward or predictable as a lower propensity to travel by plane or go to a bar, and the report posits the idea that sub-groups of consumers could emerge, providing adaptive companies with opportunities. However, the potential for this theme to “evaporate or become entirely redefined because of a single medical discovery” leaves it a risky investment proposition.
Finally, Goldman thinks investors need to be mindful of the regulatory response in and to our brave new world. Lawmakers’ newfound focus on safety and protecting the public is likely to benefit larger companies with the resources to absorb compliance costs, while punishing the sectors and companies that have already suffered from lockdown or various distancing measures. Should consolidation lead to excessive market power, expect competition concerns to grow louder.
In summary, the investment bank believes that flexibility, resilience and specialisation will win out. While none of those insights are particularly original, their interplay – and the evanescent role of fortune – are worth bearing in mind as investors emerge from (or are forced to live with) the age of Covid-19.
‘The Great Reset: A Framework for Investing After Covid-19’ can be read in full here.
