Bouncing Back: How High, How Quickly?
With the recent release of the final measure of first quarter GDP, which registered -5.0%, investor attention is now migrating to the anticipated result for the quarter just ended. Many estimates of second quarter GDP, which felt the full impact of the coronavirus pandemic, fall into a range of -30.0% to -40.0%, a level of contraction not previously seen in a post-World War II era. One of the key takeaways from the steep decline in economic activity during the second quarter is that it is expected to represent the trough, and that increases in GDP will resume over the remainder of 2020 and into 2021.
While there is a consensus economic growth will rebound in the third quarter, the range of estimates for the period is wide and extends from a rapid return to pre-pandemic levels of economic activity to a multi-year recovery trajectory. Numerically third quarter GDP is forecasted to grow anywhere from 12% to 20%. This dispersion in expectations is reflected in the various single letter descriptors being utilized to characterize the recovery. Will the trajectory of the recovery take the shape of the letter V, an L or perhaps a W? Currently, our expectation is for a recovery that does not adhere to any letter in the alphabet but rather in the shape of Nike’s trademark swoosh. Utilizing the swoosh as our preferred recovery metaphor demonstrates our view that the second quarter, with its severe contraction in economic activity, represents the trough and future quarters will see a return to positive GDP for the U.S. economy. The rate of growth from the trough, while meaningful, will not accelerate at the same pace as the decline experienced in the first half.
Our rationale for this outlook is based in part on a belief that many businesses will not reopen to full capacity as quickly as they shut down in March and April. A few examples of this gradual reopening process include restaurants, movie theaters and sporting events. Various data points are being utilized in evaluating the ongoing process of reopening the U.S. economy. In addition to traditional measures such as jobless claims and Institute of Supply Management surveys, we are monitoring items like movie theater box office receipts, the number of passengers passing through TSA checkpoints at airports, hotel occupancy rates and OpenTable’s State of the Restaurant Industry data. For example, the seven-day moving average for TSA checkpoint data increased 97.8% as of June 29. While this was a significant increase, the year-over-year result is -77.6%, which indicates air travel is still well below levels prior to the pandemic.
The economic impact of the coronavirus pandemic is not just a domestic event, as it is being fully experienced outside the United States as well. Global GDP, including the United States, is forecast to register -4.9% for the year according to the International Monetary Fund. Advanced economies are anticipated to fare the worst with Europe and the United Kingdom expected to experience the steepest declines. Within emerging market countries, Mexico is forecast to have the most meaningful decline at -10.5%.
Performance Overview
As has been well documented, the policy response to the pandemic’s economic impact was quickly implemented and immense in size. Action was taken on both the monetary and fiscal policy fronts with the potential for additional stimulus infusions continuing to be discussed.
Recalling criticisms during the financial crisis of 2008-2009 that stimulus measures were too slow in being implemented, the Federal Reserve and Congress were determined to avoid a repeat of that scenario. Risk assets, such as equities, were major beneficiaries of the stimulus. The S&P 500 Index provides an example of second quarter market performance. The index had positive returns all three months of the quarter and generated its strongest quarterly return since the fourth quarter of 1998. Corporate bond performance was also a beneficiary of policy stimulus as that segment of the market
returned 8.2% during the quarter versus 0.5% for U.S. Treasuries. Going forward, interest rates are expected to stay within a range around current levels as inflation rates remain low and monetary policy officials remain at the ready to support liquidity needs and help stimulate economic growth.
Asset Allocation Review and Outlook
With the strong performance delivered by financial assets in the second quarter, each of our five investment objectives generated robust returns for the period. Our balanced and growth-oriented models benefited from our emphasis on domestic equities as U.S. stocks continued to deliver superior returns relative to broad foreign market indices. Fixed income also made a meaningful contribution to performance during the quarter as indicated by the Bloomberg Barclays Aggregate Bond Index return of 2.9% for the three-month period.
As we transition into the third quarter, we maintain our current asset allocation targets that, for balanced investment objectives, continue to overweight equities relative to fixed income. Within the equity allocation, we continue our emphasis on domestic equities with an overweight to that segment, while foreign equities are represented with a weight that is neutral to our benchmarks. We are keeping our overweight to domestic equities despite their strong second quarter performance. This decision is based on our belief the economy will return to growth mode and that stimulus, particularly from monetary policy, will continue to create a favorable environment for equities.
Maintaining our current allocations and continuing to favor equities over fixed income and domestic equities over foreign equities is not to imply a sanguine view of the economy or financial markets. With the pandemic still in place and multiple states reporting an increasing level of virus cases, we readily acknowledge a heightened level of uncertainty. To help offset this uncertainty, we continually review economic data and market developments and evaluate them to determine and validate our convictions on asset allocation and underlying asset classes. One of the tenets of our investment philosophy is that we take a long-term view of the markets. Our adherence to this tenet leads us to maintain positioning, looking through short-term events and filtering out the noise until our analysis and outlook reveal adjustments are needed.
Also, it is periods like the first half of 2020 that provide incentive for investors to review their investment objectives and associated asset allocations to ensure they are appropriate given their time horizon and level of risk tolerance.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.