The Bumpy Road to Recovery
Earlier this year, global economies suffered rapid and intensive damage resulting from the Covid-19 pandemic. The shelter-in-place lockdowns needed to limit the extent of the virus outbreak caused significant collateral damage to the overall economy. Generous government support for the unemployed, in addition to massive capital outlays for businesses and credit markets, kept the economic recession from morphing into a full-blown depression. The economy exhibited clear signs of a rebound in May and the S&P 500 experienced an epic reversal of fortune, rising 56% from the low in late March and thereby more than regaining all the ground stocks lost in the first three months of the year. However, the recent reacceleration of the virus makes clear just how fragile and uneven the recovery can be and also reiterates not to underestimate the continued impact of our microscopic nemesis.
Most of the major economic indicators confirm that the U.S. economy plunged during March and April as a result of lockdowns imposed by state governors to enforce social distancing. The majority of them started to recover during May as shelter-in-place restrictions gradually eased. For example, significant sequential improvements were seen recently in retail sales, consumer spending, durable goods orders, manufacturing production and home sales. The labor market also strengthened faster than most economists anticipated, with the unemployment rate in August declining to 8.4% from near 15% in April. While the number of unemployed still remains elevated, the trend is decidedly headed in the right direction.
A new economic expansion has begun at an initial pace that has surprised many. Pent-up demand which accumulated during the lockdown provided the initial boost to the economy as businesses began to open again. Additional fiscal stimulus is also widely anticipated to be forthcoming soon to maintain economic momentum and provide a safety net for those still out of work. Most importantly, the wealth effect, where consumers spend more as they feel financially secure, provides the foundation for future economic growth. The last five times stocks increased by an amount similar to the second quarter, GDP increased on average 4% the following quarter and 5% the quarter after that. There is a reinforcement loop in place where strength in stocks leads to economic growth and vice versa.
This early in the recovery it is still premature to predict with any accuracy when the economy will return to where it was when the last expansion came to an abrupt end in February. The damage from the pandemic was deep, wide and sudden. Despite this downturn likely being the shortest on record, most economists do not expect the economy to recover prior output levels before the end of the year. Additionally, the journey back will not be without challenges along the way. The current increase in coronavirus cases is causing some reopening activity to pause or even go into reverse, dampening some of the economic gains that were recently achieved. Despite the rise in new cases, no full shutdowns are again being contemplated as we have better protocols in place to handle the virus. With experience comes knowledge.
The U.S. economy is also being reshaped by the pandemic. Fewer jobs will exist in airlines, hotels, restaurants and traditional retail, while more will be created in e-commerce and technology industries. Transitioning our workforce into these new roles will take time.
The reopening process will continue to deliver economic advances and setbacks, many driven by the state of public health. Therapeutic treatments for the disease have already begun to be made available and we are likely to see effective vaccine results from large ongoing trials in the coming months. Widespread vaccine availability should occur early next year with emergency use possible later this year. Diminishing the impact of the virus may not be that far off in the distance.
Putting the virus aside, the other immediate concern for the economy and the markets focuses on the upcoming election. With his recent rise in the polls, investors are becoming more interested in learning the details behind Joe Biden’s economic plan. He is proposing to spend $400 billion on American products and services over four years as well as investing $300 billion on U.S.-based research and development involving emerging technologies such as electric cars, artificial intelligence and 5G communication networks. Biden also wants to reduce dependence on foreign countries to supply the U.S. with essential goods. Additionally, he is formulating plans regarding infrastructure and clean energy. None of these initiatives have made investors nervous so far despite vowing to pay for this incremental spending by reversing some corporate tax cuts and increasing the tax burden on the wealthy. It is also worth bearing in mind that stocks have done very well under the prior two Democratic administrations.
In summary, economic indicators suggest the economy bottomed in the second quarter and the recovery is global in scope. The uptick in virus cases will not cause another complete shutdown of the economy, but will negatively impact the pace of the recovery in the near-term. Additional government stimulus, if needed, will sustain economic momentum. Gains from stocks will also boost the economy. A medical solution for the pandemic should be emerging.
Holger Berndt, CFA
Director of Research
hberndt@rssic.com