After a dismal first quarter for global stock markets, the second quarter was a welcome reprieve. Equity markets staged a fierce rally during the second quarter as investors bet on a quick resolution to the Covid-19 pandemic. However, stocks returned to selling pressure the past two weeks as cases have begun to spike across the U.S., leading to fears that the economic recovery will not be as smooth as many hoped. The unpredictable nature of Covid-19 makes forecasting very difficult and it is likely that a true recovery will not be seen until a vaccine is readily available. When the economy does recover, many industries will be forever changed and will be faced with a new normal.
The scope of our current economic damage is truly remarkable. Over 47 million Americans have filed for unemployment benefits. First quarter GDP contracted at a 5% annualized rate, and consensus second quarter GDP is expected to contract at a 25% rate. In U.S. history, we have never seen a quarterly number anywhere close to this bad. Estimates are that 25% of restaurants will not survive. The U.S. government has handed out over $3 trillion in stimulus funds, four times the amount given out in 2008.
Many people are asking why, in the face of all these scary numbers, is the stock market rising? There are two reasons this is happening. First, the equity markets do nothing but discount future expectations, and investors feel that once the virus is gone, economic conditions will improve. Secondly, investors are betting on a quick recovery once this happens. We agree with the first part of this. Economic growth will recover when compared to lockdown conditions. We are not as convinced about the second part of this. While a vaccine may be developed within a year, it may not. The fastest a viable vaccine has ever been developed is four years, and there’s never been a vaccine developed against a coronavirus. Predicting that a vaccine will be ready to go in less than a year, while possible, seems overly optimistic. Also, the likelihood that we return to the pre pandemic level of GDP quickly is unrealistic. Economic consensus is that the U.S. economy will take 5-7 years to fully recover. The Congressional Budget Office (CBO) has marked down its ten-year estimate of U.S. economic output by a cumulative $15.7 trillion.
There has been much discussion about what the economic recovery will look like. V shaped, W shaped, U shaped, L shaped. We call these the alphabet soup theories. A V shaped recovery would be the best case scenario; an L shaped recovery would be the worst. What we end up with depends on the virus. The longer it lasts, the more damage will be done to our economy and the longer the recovery will be. At this time, this is unknowable.
The spike in Covid-19 cases leads to higher uncertainty about the remainder of this year. As one economist eloquently stated, there’s a growing lack of clarity about the future. Given this uncertainty and the market’s high valuations, we remain cautious.