Themes for the Second Half of 2020

Image by Fathromi Ramdlon from Pixabay 

By KEVIN BARRY & SAM KIRBY/CAPTRUST

After its longest-ever period of growth, U.S. economic activity and markets collapsed during the first quarter in response to the initial pandemic shock and stay-at-home mandates. However, as shown in Figure One, major asset classes posted significant gains fueled by historic levels of policy support and reopening optimism during the second quarter. 

Source: Bloomberg. Click chart to enlarge.

The forces that drove markets so far in 2020 are powerful, including both the negative impacts of the virus and the positive impact of monumental stimulus and relief programs. By far, the greatest issue facing capital markets for the second half of the year is success in solving the medical crisis. Until effective treatments and vaccines are available, the economy and especially impacted industries such as travel, leisure, and hospitality will be unable to return to anything approaching normal.

But the hope is that more targeted policies can bridge the gap and contain the risks of overloaded health systems until medical solutions become available, with less severe disruption to the economy, education system, and daily life.

Policy Cushions Blow

The fiscal and monetary stimulus unleashed within the U.S. since March is not only the largest in history, it also arrived quickly, despite a fractious political environment. The combination of central bank liquidity programs and fiscal relief packages is estimated to exceed $9.5 trillion—a staggering number that represents more than 40 percent of U.S. gross domestic product (GDP).

An important driver of the future path of the recovery will be avoiding policy mistakes of the past, such as stopping stimulus too quickly during or after a crisis. Examples include the Great Depression, when monetary policy errors prolonged the crisis; the European response to the global Financial Crisis; and Japan’s Lost Decade of the 1990s.

As a result, all eyes are now on the next round of fiscal stimulus, which is expected before September.  

Labor Market Stress

The initial, heart-stopping spike of job losses in March drove the unemployment rate to 14.7 percent—the highest level since the Great Depression. As states have begun to reopen, we have seen significant improvement as workers sidelined by lockdown restrictions have been recalled. But despite these gains, the unemployment rate remains at a highly elevated and worrisome level of 10.2 percent.

Labor market recovery is a critical precursor for limiting the damage of this recession. For the remainder of 2020, we will watch closely for signs that effective virus containment efforts can coexist with job recovery, as well as any signs of increases in permanent layoffs as businesses adjust to the post-pandemic business environment. 

Balance Sheet Health

The virus isn’t the only health concern on the minds of investors and policymakers; the financial health of corporations is also in focus. We entered 2020 with storm clouds on the horizon in the form of elevated levels of corporate debt. Today, debt-saddled firms face an unprecedented revenue shock We have already seen many storied brands troubled sectors fall victim to the crisis, including Hertz, J. Crew, Gold’s Gym, Neiman Marcus, and Brooks Brothers. Already, the pace of bankruptcy filings has reached levels not seen since 2009, prompting some to fear that we could be on the brink of an avalanche of business failures.[1]

The unique nature of the current crisis does, however, allow room for optimism. During prior recessions, levels of economic activity were quick to fall, but slow to recover. This time, because the drop-off in activity was largely artificial—driven by lockdowns and social distancing requirements—we could see a sharper recovery once virus risks subside. Only time will tell. In the meantime, amid this uncertainty, it should come as no surprise that many firms have withdrawn future predictions of near-term business conditions, with more than 170 companies suspending earnings guidance over the past three months.[2] 

Election Season

Finally, markets will watch the election season unfold with great interest. This attention that will only intensify after party conventions. Although current polling suggests a lead for the Democratic challenger, we are still more than two months out from election day—an eternity in politics. Historically, presidential incumbents who faced a recession within two years of reelection have rarely won. However, this recession is anything but typical, and it remains to be seen whether this time will be different. We are mindful of the risks that a politically charged environment could slow or derail continued policy support for economic recovery and the potential escalation of trade disputes.

Investing Amid Uncertainty

The breathtaking drop and breakneck recovery we have witnessed over the past four months represents perhaps the hardest-but-greatest lesson of all time on the dangers of market timing. Those who moved to the sidelines in March missed a rally for the record books. However, investors, institutions, and retirement plan participants who stayed the course or took the opportunity to rebalance portfolios may have benefitted from some of the extreme price dislocations witnessed during the first quarter.

While we hope the next six months is a smoother ride than the last, we expect volatility to persist as markets react to the fast-changing medical, economic, and political conditions described above. This degree of uncertainty underscores the importance of risk tolerance, asset allocation, and portfolio diversification. These foundational principles can give retirement savers a greater ability to seek out the new opportunities that will undoubtedly emerge from the first global pandemic of the modern era.

Sources:

[1] Hill, Jeremy; Crombie, James “Big Bankruptcies Sweep the U.S. in Fastest Pace Since May 2009,” bloomberg.com, 2020

[2] Strategas, 2020

CAPTRUST is an Associate Member of TEXPERS.The views expressed in this article are those of the author and not necessarily CAPTRUST nor TEXPERS.

About the Authors:

Kevin Barry is CAPTRUST’s chief investment officer and leads the Investment Group, the team responsible for investment manager due diligence, asset allocation, and discretionary investment management for the firm’s wealth management and institutional advisory clients.

Sam Kirby is a leader with CAPTRUST’s Investment Strategist team. He works with the firm’s financial advisors to assist clients with investment strategy, portfolio construction, and monitoring. He has 15 years of financial services experience and is a CFA charterholder.