Economic and Financial Outlook Webinar Recap

In a recent webinar, Bailard’s Chief Investment Officer, Eric Leve, CFA, discussed the near-term economic implications of the most rapid economic decline since the Great Depression but balances that with more a more sanguine long-term view. From a financial perspective, he provides historical context to equity market downturns and subsequent rallies as well as some thoughts on how this all could play out this time.

Read below for a quick summary, or watch the webinar here.

COVID on the U.S. Economy

• The COVID-19 stimulus, which equates to 16.5% of GDP, is leading to historic debt and deficit levels, projected to surpass even WWII highs. The two paths toward erasing this debt over the long run? Generating nominal GDP growth and increasing taxes for present and future generations.
• The U.S. may have a long period of very subdued inflation. But given unknown supply/demand imbalances, the experience could be more like the post-WWII period with inflationary and deflationary spikes. We believe that the longer-term outlook for the economy is one of relatively moderate economic growth, low inflation, and low interest rates.
• Because consumer spending is critical and makes up about 70% of U.S. GDP, the economy is likely to fluctuate as the consumer’s disposable income does. Disposable income for consumers is likely to drop until Q4 of 2020. However, it’s projected that the dampened impact of the Coronavirus on consumer spending should be gone by Q3 of 2021.

COVID on the Financial Markets

• There is a strong link between GDP and corporate revenue: every 1% change in GDP results in a 2.5% change in S&P 500 revenues. With declines in GDP predicted for the coming quarter and likely longer, corporate revenues will drop in turn with smaller companies faring worse than the larger corporations that comprise the S&P 500 Index.
• The almost 11-year rally has generated a total return of 528% for the S&P 500 Index, despite many challenges that include the European sovereign debt crisis, UK Brexit vote, and Chinese equities oil crash. From this, we can conclude that the market is forward-looking and doesn’t discount history but rather that the market discounts the future.
• The Federal Reserve Board’s (the Fed) quantitative easing actions in March of this year were the initial impetus to reignite risk-taking. However, the Fed’s actions alone cannot bolster the stock market and bring long-term growth for equities.
• History has shown that there are often strong positive runs as a bear market descends to its eventual bottom. In fact, there were 14 bear market rallies during the Great Depression and 6 bear market rallies after the 2008 Great Financial Crisis. However, we may not be going up secularly from here because a steep decline and a sustained rally are the exception, not the rule.
• S&P 500 earnings may not return to 2019 levels until 2022. With low interest rates, investors may be discounting earnings even beyond the next two years. Low interest rates can support higher price-earnings ratios and extend the horizon for investors as they look to future years’ earnings.

We see two possible scenarios going forward—continued concern or renewed confidence. We examine both below.

Scenario One: Continued Concern
In the continued concern scenario, the economic picture consists of extended shelter-in-place orders that continue to disrupt businesses and/or halt their ability to re-start operations. As a result, unemployment would remain high. Many sectors may find it difficult to build a sustainable economic model with demand light and variable. GDP therefore remains flat or even declines. However, oil prices may stabilize at a higher level in order to preserve total revenues for oil companies and oil producing companies. In the stock market, weak earnings growth and relatively high valuations impede equities. Markets respond to concerns of COVID-19 and experience many rallies and sell-offs. In addition, global anxiety continues to push money into U.S. assets, keeping U.S. rates down and undermining returns for U.S. based international equity investors. Lastly, fixed income investments would remain a relative safe haven, protecting more conservative investors from downside risk.

Scenario Two:  Renewed Confidence
Alternatively, the renewed confidence scenario predicts that consumer confidence and spending rebound as re-openings bring back furloughed workers without a second wave of shelter-in-place restrictions. Minimal dislocations between the ability to produce goods and individual/ corporate spending leads to muted price volatility. Interest rates and energy prices remain low, providing a tailwind to recovery. , Equities would continue to advance higher as investors focus on increased traction for earnings late 2020/early 2021. A diminished safe haven bid for U.S. assets could then reduce upward pressure on U.S. dollar, as assets return home. A strong relief rally may support small-value stocks, which typically lead off of a bottom.

This piece has been distributed for informational purposes only and is not a recommendation of any particular strategy. It does not take into account the particular investment objectives, financial situations, or needs of individual clients. All investments have risks, including the risks that they can lose money and that the market value will fluctuate as the stock and bond markets fluctuate. There is no guarantee Bailard or any investment strategy will achieve their performance or investment objectives. The information in this publication is based primarily on data available as of May 15, 2020 and has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation are not guaranteed. In addition, this piece contains the opinions of the authors as of that date and such opinions are subject to change without notice. We do not think this publication should be relied on as a sole source of information and opinion on the subjects addressed.

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