THIRD QUARTER ECONOMIC OUTLOOK – July 15, 2020
US & World Economy
It’s no doubt that the first months of 2020 has been the most surreal months we have experienced. I’m sure many of you have similar feelings of anxiety and exhaustion due to such a remarkable threat to our health, the health of our loved ones, the challenges of closed schools, closed businesses, WFH, and ever-changing protocols for keeping safe outside our homes and in public spaces.
There has been an unprecedented amount of turmoil and volatility in the first months of 2020. We have seen our US President impeached, a pandemic spread around the globe, over 40 million US jobs lost in one month followed by the largest gain in hiring on record the next month, the passing of $7 trillion in rescue assistance to our national economy thus, another Fed Reserve balance sheet expansion after the series of Quantitative Easing programs in the 2010s, the price of oil went negative (you had to pay to get out of a delivery contract), and a nationwide wave of civil unrest and protests.
Yes, we all look forward to a post-COVID world but what will that look like? Will our recovery be a V shape or W or U or even a Nike Swoosh? There is so much that is beyond predictability. We are in midst of a strong resurgence in the number of COVID illnesses (fortunately the mortality rate is not increasing at the same rate). A worldwide race is on for the development of a vaccine, rapid testing, and effective treatment of the virus. Seemingly endless government rescue aid and balance sheet expansion programs have been deployed and will continue.
There is an immense amount of debate about what the impact of the large amounts of debt vs GDP will bring. We argue this is not the first time we have seen this expansion via QE in the US but it is the most certainly the broadest monetary campaign we have seen since WWII. Very early on, nearly all of the developed world deployed emergency pandemic liquidity simultaneously. Worldwide, debt to GDP ratios are rising yet the Fed’s balance sheet as a % of GDP is notably lower than the ECB and BoJs.
Our current view is that low-interest rates will remain very low for years to come (we had barely started an uptick in rates from the lows that came about after the 2008 Great Recession). The S&P 500 yields more than a highly rated bond. Negative interest rates across the globe will be a new normal and fiscal policy will eventually need to be modified to hold together some obligations of the Federal, State and local government to pensioners, infrastructure maintenance and public safety and assistance.
With an election looming in the coming months, the markets are also attempting to anticipate what effects the next president may have. In either case, one unifying theme that has emerged on both platforms has continued to be a renewed interest in domestic infrastructure spending. With a majority of bridges, roads, schools, and other state and government buildings falling into disrepair, there is renewed interest in rebuilding different parts of our country. Now, with the effects of increased remote work, broadband infrastructure and technology upgrades in our cities and small towns have also become a priority. Regardless of who is elected, the additional domestic spending should drive additional investment opportunities for years to come.
In the US, numerous Federal rescue actions are just beginning to expire. Most businesses that took Payroll Protection Plan loans (PPP) during the crisis spent most or all of those funds by now and may be facing very tough decisions right now about keeping on employees or even staying in business so we might see another spike in the temporarily recovering unemployment rates. And these unemployed face the end of the extra weekly income of $600 from the Federal Pandemic Unemployment Compensation on July 31st. On the flip side of this unsettling news, according to JP Morgan on July 8th, the remarkable stock market recovery since March is reaching price and lower volatility levels that will trigger Quant funds’ trading algorithms to reenter the stock market potentially adding roughly $400 Billion back into the stock market. Remember, these same Quant funds were like rocket thrusters back in March that pushed the market down so far so fast.
Everything about our world economies immediately depends on the steps taken to control and reduce the spread of COVID-19.
Many debate what our recovery will look like, and arguably our US stock markets are already pricing in a fairly optimistic future and we agree, it should. It is a fact that historically speaking, in every calendar year, the stock market has periods where equities lose value. The average of those declines is 14%; this means it is sometimes less of a decline and sometimes more of a decline, but the fact is, there is always a decline. On a longer-term perspective, the average bull market lasts 8.9 years and sees total rally returns of about 400%; the average bear market lasts 1.3 years and stocks fall about 41% through these periods. It is clearly evident that the good times far exceed the bad times. Being patient and unemotional during the shorter bear markets proves to be the best course of action.
The bear market of March 2020 has been the quickest to recover to bull market in history. The market has rebounded from its lows in March and the technology-heavy NASDAQ is hitting new all-time highs in the midst of the pandemic. This recession was not caused by over-exuberance or by a bubble but rather by an exogenous event. While the landscape coming out will look different, we believe that we will enter a new paradigm in the economy where strong and innovative companies will thrive, over-indebted and weaker businesses will fail and there be a greater push than ever for US-domiciled supply chain independence and nationalism. Staying invested with minor tactical modifications will prove the best method for generating steady returns and upside participation as the good times, we all so dearly look forward to outweighing the bad. At least in the stock market.
Stay healthy and stay optimistic. Long-term goals are still achievable.
Leslie, Matt & Optivest’s Investment Department