The U.S. economic trajectory has changed abruptly. We started 2020 with expectations for solid economic growth, and this outlook was bolstered as recently as March 6 by a U.S. Federal Reserve (Fed) forecast that U.S. first-quarter GDP growth would come in at an annual rate of 3.1%.1 However, that was before the implementation of extreme public health measures to try to stem the expansion of the coronavirus outbreak—a challenge that will have dramatic consequences for the economy and financial markets.
The coronavirus pandemic is, first and foremost, a human tragedy, and an unprecedented challenge to public health infrastructure around the globe. In terms of its economic impact in the United States, the near-complete shutdown of public events-related commerce is likely to significantly erode consumer activity and corporations’ capital spending. Based on the consensus forecast of economists across our asset management network, we’re now forecasting a modestly lower first-quarter annual growth rate of around 2%, while scaling back our estimates for subsequent quarters: a sharply negative second-quarter figure to the tune of –10% and a third-quarter number of around –2%.
While the current uncertainty remains high, we’re cautiously expecting a turnaround to positive growth in the fourth quarter, with a forecast of 3%. The negative figures that we’re forecasting for the second and third quarters would constitute a recession—two or more consecutive quarters of negative growth—with its severity hinging on the magnitude and duration of the coronavirus outbreak and the extent and effectiveness of U.S. public health measures taken to combat it. The right priorities here are public safety first and the economy second.
The policy response to today's volatility
After cutting interest rates by 0.5% on March 3, the Fed announced on March 12 that it was making $1.5 trillion in additional market liquidity available to bolster repurchase operations for U.S. Treasury securities, where liquidity had become strained.2 In short order, this move could boost the Fed’s balance sheet to well over $5 trillion—a new record high. In addition, on March 15, the Fed slashed interest rates by 100 basis points to a federal funds range of 0.00−0.25%, combined with a $700 billion quantitative easing program. Furthermore, we expect that a tax reduction or other fiscal stimulus is likely to be approved by Congress and signed into law. As the coronavirus response weighs on the economy, policy makers are trying to blunt the impact to business activity. To date, policy makers have fallen short of showing that they can assuage market volatility in any substantial or enduring way. However, the historical record from past recessions suggests that well-designed policy measures do eventually succeed in tempering volatility.
How might this bear market differ from past bears?
The speed of the drawdown in the S&P 500 Index that we’ve seen since the market climbed to a record high on February 19, 2020, has been unusually rapid; in the post-World War II era, the only decline with comparable speed was the bear market of 1987. (A bear market is generally defined as a decline of 20% or more from an equity market peak.) The average overall decline experienced in bear markets going back to 1950 was 34.6%.
We expect that the potential recovery time for a market comeback from the current drawdown could be shorter than the historical average of around four years.3 Our expectation is based in part on the fact that the current bear market’s decline has been sudden, as it was driven by the exogenous shock of the coronavirus outbreak. While this event is still unfolding—and has yet to fully manifest in the United States—we’re optimistic that it will run its course in a matter of months. Additionally, our expectations for a relatively speedy market recovery stem from the example of the 1987 bear market, the decline that we consider to be most analogous to today's bear market. That drawdown was noteworthy in part because of its speedy recovery; the S&P 500 reclaimed its pre-bear market level in less than two years.4
Diversification still matters—a lot
As to how investors respond to the recent surge in market volatility, we would continue to focus on making prudent asset allocation decisions. Volatile periods like this one—in which buying and selling are indiscriminate and price movement correlations between asset classes rise—can make it feel like diversification is irrelevant. It's important to remember that the relative risk/return spectrum—from high-quality bonds to low-quality equities—is alive and well. For this reason, in our view, there's as much value today as there has ever been in a well-balanced portfolio to help investors ride out periods of volatility.
1 GDPNow forecast, U.S. Federal Reserve Bank of Atlanta, March 6, 2020. 2 "Fed Again Upsizes How Much Money It Will Lend Wall Street," Wall Street Journal, March 11, 2020. 3 FactSet, as of March 12, 2020. 4 FactSet, 1989.