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July 1, 2020
When COVID-19 first appeared on our shores, many analysts expected the impact to be akin to a natural disaster such as a hurricane or earthquake. Under this scenario, any lost production would be recovered quickly over subsequent quarters. When the situation intensified and led to a virtual lockdown of the global economy in March and April, focus shifted towards the longer-term damage on specific industries and sectors of the economy.
Better than expected economic data in May and June increased confidence that the lockdown-induced decline bottomed in April. Various purchasing managers and consumer sentiment surveys and statistics from housing, durable goods orders, employment, and consumer spending helped confirm the sharp equity rally. By the end of second quarter, global equities and other risk-based assets had retraced a good portion of their first-quarter losses. This sharp rebound was a function of aggressive fiscal, monetary, and social policies, and hope the economy would fully reopen in the third quarter.
The stimulus checks, enhanced unemployment benefits, and business loans provided at the beginning of the crisis were meant to replace lost income and keep businesses solvent during the lockdown. Even though the jury is still out on the effectiveness of these initiatives, many are calling for another large fiscal package. However, there are concerns that the enhanced benefits may be disincentivizing individuals from returning to work. As such, it will likely take a notable deterioration in the equity markets or economic statistics to spur Congress to act.
As we head into third quarter, there are a few byproducts of the COVID-19 crisis that bear watching:
Trade. China’s perceived lack of transparency about the virus appears to have broken the fragile trade détente between the U.S. and China. Towards the end of the second quarter, trade frictions extended to Europe as the U.S. threatened retaliatory tariffs if Europe imposes a digital tax on U.S. technology companies.
U.S. elections. Recent events have widened Joe Biden’s lead over President Trump in the polls, increasing the probability of Democrats winning control of the Senate in the fall. History has shown no discernible difference in long-term equity market performance among the parties. That said, the rising probability of a Democratic sweep can be viewed as another near-term headwind for markets, given the strong advance seen in the second quarter.
Unemployment. The potential loss of state and local government jobs due to dramatic budget cuts could further slow the economic recovery unless Congress passes a substantial fiscal aid package.
Inflation. Concerns exist around the inflationary implications of the unprecedented expansion of monetary policy. But as of now, there is no indication of inflationary pressures. The global economy remains far from producing and consuming at full capacity.
The May/June economic rebound could merely be a sign of pent-up demand exploding out of the gate as the economy reopened, not a sustained recovery. The willingness of consumers to fully re-engage remains to be seen, given the continued pandemic conditions. Investors should be wary of a recurrence of virus infections and the longer-term economic damage caused by the lockdown.
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Partner & Chief Investment Officer
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