Notes on the Economy – 2Q 2020 Summary

THE GREAT LOCKDOWN

As the year 2020 opened, the global economy was turning the corner on a broad-based manufacturing slump. Progress came to a halt in February due to China’s response to COVID-19. At that time, most analysts anticipated that COVID-19 would be a regional epidemic directly affecting China and its near Asia neighbors. Now, it is obvious that those prognostications were way too optimistic.

Instead, COVID-19 has become a global pandemic, and a great global lockdown—actions taken to slow the spread of the disease—has delivered the global economy to the doorstep of recession. The world’s governments have responded with very expansionary fiscal and monetary policies. According to the International Monetary Fund (IMF), collective global fiscal support totals about $9.0 trillion. Uncertainties about the path of the pandemic, and hence for the global and national economies, are extraordinarily high. However, if the gradual lifting of restrictions on economic activity now beginning in many countries is successful, economic recoveries should begin in the second half of 2020.

The U.S. contracted at a 4.8% annualized rate in the first quarter of 2020. Consumer spending was down an annualized 7.6% as labor markets deteriorated markedly. The unemployment rate has increased from 3.5% in February to 14.7% in April. The federal government has responded with a series of COVID-19-related relief measures that aggregate an amount approximately equal to 14% of 2019 GDP.

WHAT’S IMPORTANT

• COVID-19 Has Heightened Uncertainty – The path of the economy and asset values will be determined by the course of the disease. At this point no one knows, and no one can know, what that will be.
• ZIRP Forever? – Federal Reserve (Fed) policymakers have re-established a nearly zero interest rate policy (ZIRP), among other very expansive monetary policy measures. ZIRP is likely to remain in place for years.
• Be Wary of Low Credit Quality – Investors’ hunt for income yield has left credit spreads too narrow to adequately compensate for potential increases in defaults, particularly if the anticipated economic recovery falters.
• Global Recovery Is an Opportunity – Relatively cheaper segments of the global equity market are likely to see the biggest rebounds. U.S. small and mid-cap stocks, foreign stocks, and value stocks are well positioned.

LOOKING AHEAD

The IMF forecasts global real GDP to contract 3.0% in 2020. Output for both advanced economies and for emerging and developing economies is expected to fall in 2020—the first such occurrence since the Great Depression. Global real GDP is projected to advance 5.8% in 2021. The projected growth in 2021 is far from a complete rebound. It leaves global real GDP and virtually all individual countries’ real GDPs well below that expected prior to the pandemic.

The 4.8% drop in U.S. economic output in the first quarter is only a prelude to the second quarter’s decline. Economic activity expanded solidly in January and February. In March COVID-19 containment efforts, such as stay-at-home orders, workplace shutdowns, and social distancing, began in earnest, effectively locking down large swaths of the economy. This intensified through April. Only in the latter part of May did authorities initiate some relaxation of the restrictions. So, the lockdown will produce a dramatic drop in the second quarter’s real GDP. AMG estimates an annualized decline somewhat in excess of 30%, but it could be much higher if moves to lift the lockdown lag.

Currently it appears that anti-COVID-19 restrictions will be lifted gradually, and those that materially inhibit economic activities will be pretty much extinguished in the first part of the third quarter. The initial phase of recovery should start with high single-digit percentage gains. However, some businesses (such as travel-related services) may bounce back only partially. Lingering restrictions on customer capacity and customers’ COVID-19 wariness may drag out the recovery period until early 2022.

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