Buy The Dip – Or Will The Recession Double Dip?
Some pundits are calling for a double-dip recession, but leading economic indicators suggest that’s not going to happen.
The economic recovery has played out surprisingly well – so far. The U.S. economy gained steam in the third quarter, with a broad-based V-shaped recovery fueled by supportive policy and improving labor and consumption backdrops. The pace of growth is subject to debate, but when third quarter GDP is reported, not one economist of 62 surveyed by Bloomberg expected the economy to have shrunk.
There is healthy skepticism around whether the economic rebound is genuine, but with the S&P 500 Index 50% above its March low, the market rally seems well supported by fundamentals. The September pullback appears to have been more about repositioning than a sign of real headwinds – a brief pullback, in other words, rather than the start of a larger downturn – and a durable market bottom has formed.
As the global economy shut down in March, investors struggled with trying to predict the shape of the recovery. Against the odds, U.S. retail sales recouped their pre-pandemic peak in six months, contributing to this V-shaped recovery. Contrast this with a 34-month recovery after the global financial crisis (GFC) and 16 months after the 2001-2002 recession.
The labor market continues to heal much more quickly than anticipated. The unemployment rate fell from 14.7% in April to 7.9% in September; more than half the jobs lost have been recovered. That same trajectory of improvement took three and half years after the GFC ended.
The CARES Act was the rebound’s primary support, with government transfer payments more than offsetting declines in wages and salaries. During the brief recession, disposable incomes rose. While not uncommon in a downturn, the magnitude of improvement (+34.2%) stands out.
The third quarter brought dramatic improvement in the economy and in corporate earnings, contradicting the narrative that goods and services activity has diverged from the markets. Companies broadly provided positive guidance, which helped drive upward revisions: S&P 500 earnings expectations for 2020 improved by 4%, and for 2021 by 2%.
As colder weather and the holiday season approach, despite this surprisingly positive environment, many investors continue to perceive potential hurdles. They under-appreciate the chances of the global economy returning to something akin to a pre-pandemic normal next year.
This “right tail” scenario largely depends on medical advances, such as the successful development and distribution of vaccines (or robust therapeutics). Nine potential COVID-19 vaccines are in Phase 3 clinical trials. The historical success rate of vaccines for infectious diseases in Phase 3 trials is 85%, suggesting that at least one has a good chance of approval.
As vaccines become available, governments should be able to quickly lift restrictions, boosting business and consumer confidence. With personal savings built up and pent-up demand, post-vaccine “revenge spending” could drive economic growth above long-term averages.
Inventories are at low levels, with many businesses trying to cut costs in any way they can; a restocking cycle would further drive economic activity. Our macro backdrop – lower interest rates, a weaker dollar and reduced energy costs – has historically fueled robust recoveries.
Before the pandemic began in February, the U.S. economy was suffering from no obvious structural imbalances. This is vastly different from the experience of the last recession when banks and households were forced to de-lever and work off excesses over the following years.
Without the traditional recessionary overhangs, there are distinct possibilities for a faster-than-average recovery. This depends upon government support to continue keeping macro damage in check. The U.S. Federal Reserve is positioning to remain ultra-accommodative for the foreseeable future, but the longer policymakers wait to continue support, the greater the risk of policy errors.
We believe another round of stimulus will be passed in the next quarter or two. This should help financial markets weather the increased anxiety and volatility that elections usually spark.
While the “right tail” scenario may prove overly optimistic as bumps in the road inevitably occur, the long-term prospects for the U.S. economy remain bright. For investors who also take the long view, we believe we’re in a “buy the dip” moment rather than the start of a double dip recession.
Jeff Schulze is an investment strategist at ClearBridge Investments, a subsidiary of Franklin Templeton. His predictions are not intended to be relied upon as a forecast of actual future events or performance or investment advice.
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