Stocks ended the week higher, with the month of May marking the start of the gradual reopening of the domestic and global economy. A steady but slow decline in new infections has allowed the partial lifting of restrictions, boosting investor confidence. The more cyclical sectors, like financials and industrials, outperformed last week, while European equities reacted positively to a proposed €750 billion recovery fund by the European Commission. The proposal requires approval by all EU members and includes €500 billion of grants to member countries. We think investment leadership will continue to rotate, supporting the case for enhanced portfolio diversification and appropriate exposure to different asset classes, geographies and sectors.
The ABCs of Recovery
The month of May marked the transition from a national April lockdown to a gradual reopening of the domestic and global economy. Markets have continued to rally with the reopening due to optimism around an economic recovery later this year as well as promising news of rapid progress and a shortened timeline for a COVID-19 vaccine. Last week the S&P Index hit a milestone, topping 3000 for the first time since February1. The S&P 500 closed the month up 32% from the March 23 low and down just 9.6% from the February high1.
The durability of the market rally is likely dependent on the path to recovery from the COVID-19-triggered economic downturn. U.S. GDP is forecast to decline 40% annualized in the second quarter, the largest quarterly decline since the Great Depression1. While there is wide agreement about a recovery taking shape in the second half of the year, there is less clarity on how long it will take the economy to rebound back to pre-pandemic levels and resume its previous growth trajectory. A review of past downturns shows that the magnitude and duration of recessions can vary dramatically. For that reason, it's often useful to describe the path from recession to recovery with a letter of the alphabet. Three common letters to describe a recovery include
a V-shaped recovery: a steep a downturn followed by a quick bounce-back of economic activity;
a U-shaped recovery: a protracted decline in the economy followed by a slow rebound back to baseline activity; and
an L-shaped recovery: an economy that never fully regains its growth trajectory after the downturn.
While these letter shapes are good theoretical shorthand, it's likely that the actual recovery from the global pandemic, and the unprecedented global efforts to contain its spread through social containment and business closures, will be shaped by a different set of letters altogether. Below we discuss the ABCs that we believe will determine the shape and length of the road to recovery for the U.S. and global economy.
A: Aggressive Federal Response – The policy response to the economic downturn in the U.S. and other developed countries is both greater in magnitude and earlier in the recession than previous downturns.
To date, the fiscal response of G20 countries to the COVID-19 pandemic has totaled 3.5% of G20 GDP1. This level of spending compares with just 0.5% of GDP in the first year of the 2008-2009 financial crisis1. G20 countries have provided lifelines to hard-hit consumers and businesses through spending increases, like wage subsidies and direct payments. Governments have also provided cash injections of liquidity to companies through low-cost loans and loan guarantees, totaling an estimated $4.5 trillion globally1.
The response at the fiscal level is also amplified by aggressive monetary stimulus by major central banks. The U.S. Federal Reserve has slashed policy rates to near zero and pledged to buy bonds in almost all segments of the credit market, including government and mortgage securities and corporate and municipal bonds. Since the viral outbreak the Fed's purchases of bonds have increased its balance sheet from roughly $4 trillion before the pandemic to $7.1 trillion in order to improve bond-market functioning in the short term and help stimulate the economy in the recovery1.
B: Balancing Business as Usual With Bending the COVID-19 Curve – Since the downturn was triggered by a biological crisis, and not a financial one, the timeline to recovery will be based on continued advancements in treatments, testing and vaccines that support the safe reopening of the U.S. and global economy.
Much will be learned over the next two months on whether states and municipalities can safely reopen and reduce physical-distancing requirements without the occurrence of a second wave of new coronavirus cases. While the U.S. has seen a decrease in the rate of new cases over time, progress towards bending the curve of new infections has leveled off recently. The welcomed absence of both a national spike in new cases and a second wave of the pandemic, thus far, is good news. Continued progress in limiting the spread of the disease will make the recovery stronger and more durable, in our view.
C: Changes in Consumer Spending and Behavior – The path to recovery will be determined in large part by 1) the ability of consumers to withstand COVID-19's economic toll and 2) public confidence in resuming normal economic activities.
Consumers are the engine of the U.S. economy, and their spending accounts for two-thirds of economic growth. Therefore, the economic recovery is tightly linked to financially and physically healthy consumers. The economic impact of COVID-19 for the consumer has been seen most acutely in labor markets. In the last two months jobless claims from workers laid off or furloughed due to the COVID-19 shutdown has reached 40 million in the U.S. Even though these numbers are dire, there have been recent green shoots of good news. The number of weekly jobless claims, though still more than triple previous recession highs, has slowed from 6.8 million in late March to 2.1 million new claims last week2. Moreover, the total number of people currently receiving jobless benefits fell to 21.1 million in mid-May, from 24.9 million the week before, as businesses have started to reopen and rehire their workers2.
However, recovery of consumer spending is not just economic, but also behavioral and based on whether consumers feel safe engaging in economic activities that put them in close physical contact with others, like going to restaurants and using public transit. A widely followed measure of consumer sentiment showed that the two-month decline in consumer confidence in March and April was the largest on record1. More recent data for May, released last week, signaled that consumer confidence is stabilizing at low levels, but not falling further. How soon consumers will be eager to spend again will be key in determining the timeline to recovery. If consumers feel confident and safe, the recovery back to pre-pandemic levels will be shorter and more vigorous, in our view.
The Letters That Matter Most to Investors: D for Diversification, E for Expectations, and F for Financial Goals.
Because the economic fundamentals supporting the rally are still uncertain, we expect occasional pullbacks in the equity rally. Diversification across asset classes, realistic expectations and a long-term perspective, and a focus on achieving financial goals over time rather than on short-lived headlines can help make the economic journey from recession to recovery a smoother ride for investors.