Of the many unknowns in the current economic environment, the most anticipated data point became a known fact last week. The U.S. economy shrank at a quarterly annualized historic rate of -32.9%, as measured by GDP (gross domestic product growth). Yes, you read that correctly. Such a contraction marks the single worst downside in U.S. history dating back to the earliest conceived data point. The expectation from economists ranged from -41% through -25%, which means the overwhelming consensus was undoubtedly to the downside, yet the severity of the contraction remained a mystery. In fact, the entire economic and market impact of the manually induced economic coma (due to COVID-19) has been a mystery. It has not been a mystery in the sense of what is happening in society and its impact to healthcare but rather a mystery to the fundamental impact to businesses and the economy. Not only have economists failed to come even close to actual estimates across an array of data points, but the same has held true for the earnings backdrop. Last week’s commentary focused on the fact that earnings have certainly dropped due to a manually halted demand backdrop, yet the actual contractions have been notably less severe than had been anticipated. This follows the notion that manually induced event-driven economic downturns are by far the hardest to gauge and the hardest to unravel (reference our video commentary from May 2020 where we extensively discussed this topic, along with the reasons investors should take advantage of the situation before it disappears). From an equity market standpoint, the GDP announcement remained largely uneventful as the FTSE All World Equity Index gained over +0.60% for the week. Investors’ expectation of the economic impact may have been priced-in to the upside since April and May 2020. As we have stated before, the quick nature of gains since the market bottom of March 23rd should not come as a shock. The historical observation of event-driven bear markets has supported the recent fastest recovery in U.S. history. We extensively discussed this in our ‘Snapbacks’ video commentary from late April and we continue to believe the backdrop remains supportive for investors over the next five years.
Sticking to the topic of witnessing history, the recent GDP figure did not only post the worst single quarterly reading in history, but it also marks the first time ever that the U.S. economy has shrunk on a rolling medium-term basis. Let me unpack that a little more. Economists reference the ‘short-to-medium-term’ time frame as 3-5 years (to make the analysis easier, I chose 4 years as the comparison time frame). When tracking a rolling economic growth rate of 16 quarters (i.e. 4 years), the U.S. economy had never contracted post World War II. Despite the severity of the recessions in the 1970s, 1980s, and the most recent Great Financial Crisis, the economy never shrank on a medium-term basis. That is a fact that not many investors realize, and it is why we always emphasize the focus on time frames above 3-5 years. The recent GDP figure, however, changed that. The U.S. economy has now contracted, on a medium-term basis, for the first time in modern economic history. This further amplifies the tremendous impact of the COVID-19 event driven economic downturn.
At the end of the day, what does this mean for the next 5 years? From a non-emotional standpoint, it is difficult for investors to envision anything past the next 5 weeks, let alone gauge the environment over the next 5 years. Such a mindset is amplified by on-going uncertainty tied to the presidential election, COVID-19, and all other factors that may materialize over the next few months. What we do know, however, is that the economy has never been in a worst situation before – ever. This may also suggest that things could certainly appear bleaker over the next 6 months, but the likelihood of renewed and sustained growth may be the next economic step past the initial short-term uncertainties. As COVID-19 becomes a lesser issue in 2021, the likelihood of the economy recovering its recent historic downside remains in our favor, especially from a global perspective.
Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management
Investment advice offered through CX Institutional, a registered investment advisor..
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
All return data sourced from Bloomberg.
All other data soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations.
Small Business Optimism sourced through NFIB. Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan.
Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites. Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.
FTSE All-World index series is a stock market index that covers over 3,100 companies in 47 countries. It is calculated and published by the FTSE Group, a wholly owned subsidiary of the London Stock Exchange and which originated as a joint venture between the Financial Times and the London Stock Exchange.