Long-Term Investors, Don’t Let a Recession Faze You
- Path of the economy/markets will be driven by the path of the virus
- Recession was officially declared; started in February
- The unemployment rate, a lagging indicator, fell in June to 11.1%; still relatively high
- Partial opening of economies has been supportive of markets
- Stocks surge as governments and central banks provide unprecedented aid
- Nasdaq reaches new highs
Reasons for concern:
- Health crisis continues, total cost of economic fallout still unknown
- Low bond yields translate to lower expected returns
Putting the pieces together
If the first quarter of 2020 was a quarter unlike we had seen before, I think we can agree the second quarter was equally dizzying. Before we get into what occurred and what it means for investors, we want to express that we sincerely hope everyone is safe and well. From cancelled graduations and summer vacations to working from home, we all have had to adjust in some ways; but rather than focus on the negative changes, we prefer to focus on the positives like more time to spend with family or time to start a new hobby.
If we think about the markets and economy as a puzzle that was in scattered pieces from a sharp decline in the first quarter, the second quarter was spent trying to start to put those pieces back together. Not surprisingly, there have been fits and starts. If we think back to April, we saw unemployment jump to 14.7%, the highest level recorded since the Bureau of Labor Statistics (BLS) started recording the data in 1948 (if not for a misclassification issue in April and May, the reported unemployment rate would have been 19.7% and 16.3% respectively). What made this increase so surprising was the speed with which it happened; in February 2020 the unemployment rate was the lowest it had been in 50 years (3.5%). In April we experienced something we probably never thought we would - negative oil prices. While some of this was a technicality stemming from how oil trades on futures markets, it was emblematic of both a stalled global economy and a glut of oil with nowhere to store it.
Fast forward to May and we had another first-time experience, the Fed began purchasing ETFs that invest in corporate bonds as a way to rapidly provide stability for credit markets. While we aren’t buyers of specific products simply because of this, Fed buying certainly supported some of our corporate bond positions. As they say, don’t fight the Fed. Despite the uncertainty and instability, we saw stocks rise on headlines a vaccine may be coming sooner than originally expected. Unemployment eased slightly to 13.3% in May.
Optimism continued in June as more economies opened across the globe. It was also in June that the National Bureau of Economic Research (NBER) officially declared that a recession started in February 2020, ending the longest expansion on record. Stocks rose and fell throughout the month based on updated coronavirus data.
What does all this mean for investors? Richmond Fed President Thomas Barkin said it best when he explained his economic outlook as “We took the elevator down, but we're going to need to take the stairs back up”. Economists have come up with a variety of shapes (see Exhibit 1) that an economic recovery might take, each of which are highly dependent on the uncertain path the virus takes. Of course, any treatments or vaccines that come about will have an almost immediate impact to the trajectory taken.
Overall, we continue to believe the depth and duration of the economic crisis will be determined by the depth and duration of the health crisis. While we see economies opening across the globe, it is happening for different sectors and different countries at varying paces and we must remember the global pandemic is still with us. At the same time, we would not recommend making changes to your portfolio allocation based on market prognostications, and we should continue to look for rebalancing opportunities as markets fluctuate.
Why are the markets going up when the economic statistics seem so gloomy?
This was the most common question asked by clients throughout the quarter as there was an apparent disconnect between economic data and market results. The reality is the market and economy are normally disconnected, though it may not always be this obvious.
If we think about the disconnect, it’s really important to remember the speed in which the global economy shut down and how abruptly and sharply markets fell. From there, global monetary and fiscal aid provided almost immediate stability and support for markets. It is also important to remember that many economic statistics, like unemployment for example, are backward looking while the markets are really a forward-looking mechanism. If you think about any individual stock, its current value is based on the present value of its expected future earnings, not its past earnings. Anecdotally, it is suggested the markets are looking out six months ahead of where we are today. With that in mind, it is typical for markets to improve before a recession has ended, reflecting future optimism.
We understand it can sometimes be uncomfortable to invest in times of higher volatility and uncertainty. Investors will often express a desire to go to cash until a point in which markets “stabilize.” However, how will we know when markets stabilize? We know there won’t be a headline telling us when this happens. On the contrary, we do know that it is during these times of uncertainty when the possibility for higher equity returns exist and there is no way for us to achieve them if we are not invested.
Questions or comments? Don't hesitate to reach out - we'd love to hear from you.
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