Recessions are a normal part of the business cycle. However, the COVID-19-induced recession was not normal. Social distancing has worked to reduce both the number of cases and deaths caused by the virus, but these same efforts have unfortunately led to mounting economic costs. With some states beginning to ease restrictions, optimistic investors have been looking beyond today’s awful data and focusing on economic recovery.
As the economy reopens, there is much to debate about the shape of its recovery, which is indicative of its speed. Will the fall and subsequent rise be quick like a V shape, or will we be at the bottom a little longer, like a U shape? The most common shapes are V-shaped, L-shaped, and U-shaped. All three begin with a sharp drop in economic growth, with the ensuing recovery defining the shape. In our opinion, the most likely scenario is U-shaped, where the recovery is positive, albeit at a slow pace. We feel that the economic pain in this recession is front-loaded, and April will likely represent the data rock bottom, with readings on employment, services, and manufacturing likely improving after the gradual reopening of the economy this month.
Our second prediction is that markets will remain volatile, but are not likely to hit the lows seen in late March. On the positive front, there are reasons to be optimistic: government stimulus should help bridge the gap until we see clear evidence of an economic recovery; social distancing and other containment measures have helped slow the growth of the virus; and lifting of social distancing measures this month is a positive surprise to equity investors. On the other hand, this year’s severe drop in corporate earnings and the economic fallout from sharply lower oil prices will continue to weigh on investor sentiment. Moreover, projected corporate earnings relative to their stock prices recently hit their highest level in over 15 years for large U.S. companies. While these market-opposing forces will likely cause a lot of sharp movements, keep in mind that markets tend to average a correction about once every 12 months, so these pullbacks are fairly normal.
Our final prediction for the rest of this year is that we will likely see different companies lead the markets. For some time, the U.S. stock market has been led by a handful of companies primarily in the technology sector. Since technology is the largest weighting within the large cap growth asset class, this asset class has been the domestic frontrunner. That said, recessions have historically had consequences that have led to shifts in market dynamics. We believe this current recession will not be different, and one likely outcome is that the current narrowness will not last.
These expectations represent our base-case scenario, but are subject to change if unanticipated events occur, such as a renewed U.S.-China trade war, the emergence of a second wave of virus in the fall, or a vaccine is developed. We continue to recommend sticking to risk tolerances consistent with your long-term goals and objectives, and being diversified among sectors and asset classes. We do think there will continue to be opportunities in this market, but we are looking for more certainty before we declare an all-clear signal. These are challenging times, but my team and I can help you stay on course.
The views stated in this piece are not necessarily the opinion of the broker-dealer and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing. The S&P 500 is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.