April 28, 2020

In stark contrast to the strong economic trends that were in place earlier this year, the threat of COVID-19 and the corresponding government response to effectively stop all business activity, except essential services, has resulted in a deep global recession. GDP in the U.S. is projected to decline significantly in both the first and second quarters before rebounding later this year. The response from the Federal Reserve and Federal government has been significant and was put in place in record time—a $2 trillion fiscal spending plan is now in place and the Federal Reserve is making every effort to ensure that the “financial plumbing” of the country remains intact by implementing unlimited quantitative easing as well as $2.3 trillion in additional measures. When taken together, these programs could result in a whopping $6 trillion, or 30% of GDP, in support of the economy. Given the unique nature of this slowdown, these programs are aimed at maintaining, rather than stimulating, the economy. However, when shelter-in-place directives are relaxed, we would expect these initiatives to potentially have a positive stimulative impact on the economy.

Of course, this will depend on the overall disease state and the resulting timeline for reopening the economy. According to widely used projections from the University of Washington, the U.S. experienced peak infections in mid-April. While this infectious outbreak is unlike any other that we have experienced in our lifetimes, it is still relevant to look to previous outbreaks and, during those times, the market bottomed when infections peaked. Furthermore, the effort being put forth by the medical community to develop diagnostic tests, therapies and vaccines to potentially test for, treat and prevent COVID-19 is notable and it will hopefully only be a matter of time before a meaningful positive development is announced. While it is still early, there are indications that some treatments under development may be shortening hospital stays and improving outcomes, which suggests that these efforts may significantly help until a vaccine can be developed.

Despite the severity of the economic slowdown, the fact that this was driven by an outside shock rather than a major structural imbalance, such as an asset bubble—that can take years to unwind—should mean that business activity will resume at a faster pace.  Research performed by Goldman Sachs shows that, historically, event-driven recessions like this one have recovered in about 15 months, which compares quite favorably to the recovery period following structural recessions, which have lasted an average of 111 months.

As we have experienced thus far, the stock and bond markets can move quickly, and in both directions. Just this year alone, the S&P 500 has fallen more than 34% before recovering 28% from those lows, all within about eight weeks’ time. Over the coming weeks, we will be hearing more bad news regarding the overall state of the economy, as well as corporate earnings and unemployment, and together this will likely contribute to ongoing volatility. There is no doubt that some companies, small and large, will fail in this environment; and there could be lasting impacts that are felt for years, particularly in more heavily affected industries. Importantly, though, the stock market is typically forward-looking and, during previous recessions, has bottomed well before the economic picture began to look better.

And yet, this time, the swift and pronounced move upward from the March lows has left many observers scratching their heads and wondering if the stock market has become completely disengaged from the reality that millions are now unemployed, and that we are still in the midst of a severe global pandemic with no clear playbook on how the economy will reopen. These are all very real and legitimate concerns, but the market is a discounting mechanism and market participants are collectively looking past what they know will be an ugly year in 2020, and instead to 2021 when the world might be considerably different than it is right now. In 12-18 months, there may be a vaccine as well as an effective treatment for the disease, that would allow business, and life in general, to get back to normal (or something much closer to it). The economy might also be supported in a more positive way by the significant monetary and fiscal stimulus that was implemented during the worst of times, and the unemployed may find that they are hired back at a much faster pace than they would have been during a structural recession, rather than this event-driven type. Furthermore, the composition of the S&P 500 is such that almost 80% of the index is comprised of industries such as technology, health care, and consumer staples that should be less impacted by the economic downturn. This is what the market seems to be evaluating now. However, given the unprecedented nature of this environment, we would expect to experience more periods of volatility along the way, as states attempt to individually navigate the economic reopening process and as we inevitably deal with a pickup in the overall rate of infection,  the magnitude of which is unknown.

Despite this ongoing uncertainty, it is times like this that present compelling long-term investment opportunities. Throughout this tumultuous and difficult period, many high-quality stocks and bonds have corrected, along with everything else, and we have used these outcomes as opportunities to selectively and tactically rebalance and add exposure, where we have felt it was most appropriate. Buying high-quality assets when they are “on sale” is typically an effective strategy. Taking a longer-term view is also important, and we have felt that prices are likely to eventually recover within 6-9 months’ time. As hard as it can be to stay the course during such trying times, history has repeatedly shown that staying invested, and not trying to time the market, has resulted in superior results over the long term. As always, we will continue to monitor the environment on your behalf, and we look forward to discussing our ongoing views with you soon.