Outlook and Market Review - First Quarter 2020

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A severe recession due to COVID-19 is underway. While the worst of the recession is likely to be felt in the second quarter, there are many uncertainties going forward. The self-imposed lockdown of the economy is easing, but there is no guarantee that the virus will wane or that a vaccine will be forthcoming soon. Added headwinds from potential trade tension with China and domestic unrest may also take a toll on the recovery. With this in mind, there should be caution in interpreting forecasts.

The economy shrank 5% in the first quarter of 2020 due to the early consequences of the virus outbreak. The first quarter is really just an introduction to the recession since March was the only month in the first quarter where the economy was in a lockdown. Consumption fell 4.69% as consumers began losing jobs and became more cautions. The saving rate jumped from 8.2% in February to 12.7% in March and an astounding 33% in April as consumers were largely in quarantine during these later months. Job losses mounted at the end of the first quarter where the unemployment rate was only 4.4% for March but ballooned to 14.7% in April and 13.3% in May. Over 30 million workers have lost their jobs this year to date. Jobs data are now improving more than expected as the economy slowly opens up, but the unemployment rate is expected to be around 10% for the remainder of the year.

Prompt fiscal and monetary policy stimulus has been unprecedented, but these moves offer only temporary relief to consumers and businesses who are facing lost income until a full recovery occurs. An effective vaccine is not likely before the middle of 2021. Even so, a full recovery is not likely until later in 2022, if there are no other major disruptions. Mounting debt will pose longer run headwinds for growth. The Federal government debt burden will exceed 25 trillion dollars this year and will be higher than the U. S. GDP. Another round of fiscal stimulus should occur this summer. Large debt burdens existed prior to the virus in many blue states, often due to poor management of pension liabilities. The added strain on state and local government finances due to the virus has partly been addressed by the Fed through debt purchasing programs. However, this program has been uneven and not all states and local governments have benefitted.

Looking forward, the Fed is committed to keeping the federal funds rate near zero and to continue easy money policies through 2022. Forecasts call for a dismal second quarter with GDP contraction around 33%, but with a recovery starting in the third quarter. A V-shaped recovery is expected with relatively high GDP growth later in the year. All this is optimistic if the virus is not contained. Inflation and interest rates will remain low, although there may be upward pressure on longer term rates as government borrowing increases and the dollar cools. Equity values are hard to understand in this market as stock prices are out of line with sentiment and earnings growth. Applications of discounted cash flow models suggest that it takes an equity risk premium of only about 3% to justify current valuations compared to a more normal 6%.