There is no shortage of guessing these days as to what our future may look like. Some guesses are rosy. Some are dark and cloudy.
What we do know now is that the 1st Quarter 2020 saw a steep contraction by 4.8%. Stay-at-home orders were issued across the country and much of the developed world. The US orders came in mid-March, so we have not yet seen the full impact of those orders. Our first glimpse will be in the April employment report that is expected to be historic later this week. By the time we get the 2nd Quarter GDP numbers, we may even have had an official declaration of recession.
On this bleak backdrop, is it more likely that the markets will plunge from here, or are they likely to continue to recover? Short term is really a guessing game and probably has more to do with how fast we are presented with credible evidence of a positive COVID-19 treatment. For the long-term we do know that most businesses, individuals, and governments (at all levels) will emerge with more debt, and debt has a direct influence upon what the future economic expansion will look like.
There was unlikely any politically attractive alternative to the amount of debt we are taking on to fight the economic tsunami brought about by COVID-19. Socially, it would have been a nightmare to simply require business to fall on the sword without any assistance. However, debt must be paid someday by somebody. Once we are past the worst of this, that will be a reality.
Historically, when debt has been high, corporate growth has been lower than when debt is low. This does not mean that stock markets cannot perform at all, but market returns tend to be slower. Surprisingly, with the shocking drop in equity markets in March followed by a fantastic April 2020, market capitalization as a percentage of Gross Domestic Income is still very high, nearly in the top quintile historically. This is what this looks like charted back with nearly 95 years of data.
The good news is that despite the number of analogies some of the TV commentators used to compare to the great depression, the market is not that over-valued in comparison.
One lesson we might be able to learn is that even though index return growth might be expected to be lower than if we were in an undervalued market, there are probably specific sectors or stocks that could outperform in a lower growth environment even post- 2020 recession (assuming that is what we are in now). Some have been especially hurt by social-distancing and shelter-in-place. Some have had extreme short-term demand and/or supply shocks. Some businesses are forever changed or may not re-open at all.
This might be a great time to remind ourselves that as investors, we should look at further time-horizons than a few months to look at investment opportunities. The next few months as we experiment with reopening the economy and wait for an effective treatment to COVID-19, there are also opportunities along with the risks. Careful evaluation is necessary, but we can be hopeful of a light at the end of this tunnel. The world we may discover on the other side may not be the same, but as we adapt, opportunity will present itself.
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