The U.S. officially entered a recession in the first quarter, and we believe this downturn is likely to be far deeper, but shorter, than the Great Financial Crisis. The picture for global growth is equally bad as COVID-19 spares no nation. The International Monetary Fund predicts that global economic output will fall by almost 5% in 2020. The full force of the U.S. economic shutdown is expected in the second quarter. We expect the economy to shrink at an annualized rate of between 25% and 30%, quarter over quarter. Economists expect a rebound in the second half that will limit the full year decline in the U.S. to between 5% and 7% compared to 2019. The initial bump from reopening has been better than expected after unemployment spiked to almost 15% in April. Government aid, in the form of expanded unemployment benefits, cash payments, and the Payroll Protection Program, has supported spending. Employers brought back workers in May, reducing the unemployment rate to 11.1% in June. Companies are coming to grips with a starkly different environment than they expected at the beginning of the year. CEOs are reducing capital spending and hiring plans, a factor that will be a persistent drag. Economic research indicates that growth will be guided as much by the public’s view of risk as policy decisions. As states reopen, cases are spiking once again, raising concerns that the nascent recovery might be at risk.
This makes forecasting especially difficult as investors try to anticipate the complex interaction between perceived risk, policy actions, and the unfolding recession. It is uncertain how well current economic data is capturing underlying economic fundamentals given significant policy distortions and questions about consumer behavior. This is an epic downturn that’s been met by an epic policy response. It’s not clear where the economy and markets would settle out without the $2 trillion in spending under the Coronavirus Aid, Relief, and Economic Security (CAREs) Act and the Fed’s bond buying. Investors, with little historical context to draw on, are falling back on a hopeful view. We’re not as certain and are concerned that the recovery may be stymied as the nation struggles to control outbreaks and Congress tentatively dials down fiscal support.
Markets are trading on unprecedented liquidity and a strong dose of hope, not on fundamentals. We are facing a myriad of imbalances, and policymakers will have to navigate them perfectly to justify current pricing. These challenges include high levels of debt in the corporate sector, unexpected structural changes to the economy stemming from the virus, and massive income and wealth inequality. The last challenge has been hiding in plain sight for over 20 years. Globalization, a shift in our economy towards services, and tax and monetary policies that favored owners of capital have accelerated and entrenched disparities. The pandemic simply exposed an imbalance that was already there. Social unrest is one sign of the times, and the coming election will continue to raise demands to address these issues through tax, spending and policy reforms. We expect the road to recovery to be bumpy and think the market is too cavalier about the prospects for rising bankruptcies, sticky unemployment, and political uncertainty. Beyond the moral imperative to shore up our civic foundation, our economic vitality depends on getting this right.