It’s hard to believe, but we’ve reached the halfway mark in 2020. If you would’ve glanced at the stock market on January 1st and then not again until June 30th, you’d see it was down, but only a modest amount. But as we are well aware, that doesn’t even begin to tell the story of the first six months of this year. The first half of 2020 contained an all-time high for stocks, a global pandemic, the deepest recession since the 1930s and the sharpest bear market drop on record, followed by a significant market rally. With all of that packed into the first half of the year, what’s in store for the second half?
The Stock Market
Volatility reached extreme levels earlier this year, sliding sharply in February and March, then rising steadily in April and May. While the first half looks similar to a “V,” we think the second half of the year may resemble a “W” trend. We are hopeful that a rebound in economic output and corporate earnings, along with ongoing monetary stimulus, should provide support for the market, but we expect volatility along the way, sparked by virus concerns, setbacks in reopening the economy and political uncertainties.
The U.S. economy endured its first recession in more than a decade, ending the longest economic expansion on record. The first quarter saw the most severe economic downturn since the Great Depression, and probably the most unique, given the self-induced shutdown driven by the global pandemic. We believe the U.S. economy is in the early stages of its recovery, but we don’t expect output to return to pre-pandemic levels quickly. We think the reopening of the economy will proceed in a “two steps forward, one step back” fashion as new cases and hot spots slow reopening plans and certain industries and regions experience lingering impacts. The pace of the recovery will be largely influenced by progress on a vaccine, which we think will be necessary for household consumption to return to pre-virus levels.
Unemployment went from a 50-year low (3.5%) in February to the highest level since the Great Depression (14.7%). Since the majority of GDP (70%) comes from consumer spending, we believe that improvement in the labor market will be the most important factor of economic recovery. The jump in payrolls over the past two months is an encouraging sign, but it will take time for unemployment to reach pre-pandemic levels. Unemployment is still above the peak level of the financial crisis (10% in 2009), so we believe a full recovery will take years, not months.
So far this year, risk has focused entirely on the economic shutdown caused by Covid-19. It is important to remember that other risks haven’t gone away. We believe other risks will re-enter the picture later this year, potentially causing other catalysts for market volatility.
Election uncertainties – The current polarized political environment will likely cause market volatility as we progress toward November. However, it is important to remember that history shows us that elections tend to be short-term catalysts for market volatility as opposed to a long-term determinant of market performance.
Trade War - We expect tougher talk related to trade with China to re-emerge this year, regardless of who wins the election. This was a key cause of market anxiety through 2018 and 2019.
Longer-term risks – Policy actions by the Federal Government & the Federal Reserve to address the economic threats of the pandemic have created potential longer-term implications. The primary implications are a bloated Federal Reserve balance sheet and rising federal budget deficits/debt. A bloated Fed balance sheet raises the potential for higher inflation down the road, while rising deficits/debt raises the potential for unfavorable fiscal choices (higher debt financing costs versus higher taxes/spending cuts). Neither of these scenarios is likely to come to a head in the next few years, but they will be lasting impacts of the pandemic policy responses. We don’t see runaway inflation or a government default playing out, but we do think inflation and interest rates will eventually rise from current levels.
Bottom Line: The first half of 2020 was unprecedented in many ways. During the 2nd half of the year, it will be important to watch the various risks that are present. It’s more important than ever to remain diversified, stick to your financial plan, and be prepared for the range of different scenarios that may play out in both markets and the global economy.