Global Recession Incoming

Global Recession Incoming

The economic consequences of the global Covid-19 outbreak and the associated decline in economic activity from quarantines, business closures, and social distancing have been staggering.  There is no question that economic activity across the globe is going to be impacted in one or way or another for at least another 3-6 months.  The consequence is that both the U.S. and world economies are going to be forced into a recession.  A recession is defined as two consecutive quarters of decline in Gross Domestic Product (GDP) growth.  Normally, it’s nearly impossible to tell if an economy is in recession until looking backwards retroactively.  However, in this case, we know that so many business are closed that there *has* be declining GDP growth for Q1 and Q2 of 2020.  I want to touch on two broadly defined topics in this article.  First, what is this recession going to look like, and how long is going to last?  Secondly, what should you be doing when you know a recession is inbound?

What will the 2020 recession look like?

I think it’s important to note that there are a lot of unknowns that could ultimately influence what the recession looks like over the long term.  Nobody knows how high mortality rates will go, how long business will be closed, and whether infection rates will continue to rise during the summer. So, with so many unknowns, what do we know about the course the recession might take?

Many of the world’s largest economies were weakening or already in recession at the start of 2020. China showed a significant slowdown in industrial output and retail sales growth in a decade near the end of 2019, even before quarantines and other business closures from the Covid-19 hurt its economy.  The U.S. had strong economic growth prior to the outbreak, and extremely low unemployment rates, but the virtual shut-down of all major airlines, travel, and tourism industries quickly reversed that trend.  Historically, recessions in the U.S. last for about four quarters (12 months).  However, because this recession is largely caused by an external forcing (a pandemic), most economic analysts from Wells Fargo, Goldman Sachs, and JP Morgan are expecting a very deep, and very short recession.  That means two quarters of GDP decline, followed by a reversal in Q3 and Q4.  Once there is a peak in virus infection rates, many are calling for increasing economic momentum and pent-up demand into the final quarter of the year. Policy measures and stimulus from the Federal Reserve and other major governments are increasing confidence in credit markets (e.g., lower interest rates, government spending on health care, and low-cost loans to small businesses), but they don’t effect the root of the problem: a global pandemic.

So putting all of this together, there is a high likely-hood that a short and deep recession will explode into higher growth rates near Q3 and Q4, particularly from pent-up demand and increased spending from both businesses and households.  Remember that the stock market is always forward looking and will respond much earlier than the economy.  If GDP recovery is expected in Q3 and Q4 the market will respond much earlier (Q2).  However, it’s important to note that this assumes that quarantines and social distancing only last a few more months.  If the pandemic continues to grow in intensity through May and June, this timeline is going to need be pushed backwards.  The potential for governments to re-open and then force new shut-downs if new infection “hot zones” expand through the summer, could also push recovery backwards as well.

What should you do with your investments?

Recently, articles from Bloomberg, Fidelity, T. Rowe Price, Vanguard, and other financial institutions have made very clear, unequivocal statements to their investors: stay the course, and don’t panic sell.  I agree with this advice.  The reasons for this are very simple.  Timing the market is impossible (for everybody, including professionals).  Nobody knows where the tops and bottoms are, and if you pull in and out of cash, you risk missing out on large rallies that will lock in your losses.  Secondly, uncertainty in markets tends to lead to overreaction.  This overreaction tends to disappear when the uncertainty is resolved.  As time goes on, there will be less unknowns about the course of the pandemic (even if they are negative), and this will calm the markets.  Moving forward, Arrow suggests higher equity allocations in portfolios as uncertainty fades, particularly focused on large-cap companies, as we expect small-caps to under perform during the recession.  In addition, technology, communication, and consumer discretionary companies will likely outperform for the rest of 2020.