Market Outlook

June 30, 2020

New Surge In Covid-19 Cases Adds To Uncertainty Of Recovery


John Boyd

After bottoming on March 23, the S&P 500 has staged an incredibly strong rebound rising 42% and flirting with new highs (the Nasdaq did manage to hit a new high before pulling back).

Initially, the rebound was driven largely by the Federal Reserve’s extremely quick, extremely massive, and open-ended response to the pandemic. It appears that they learned a valuable lesson from their slow response to the financial crisis in 2008. And Congress did its part with its own massive stimulus package. The basic idea of these measures was to provide ample liquidity to the markets, help firms stay solvent, keep workers on the payroll, and replace the lost income for those who did get laid off until the pandemic ran its course and the economy recovered. That "playbook" looked sound as new U.S. cases of Covid-19 seemingly peaked in early April and then began to slowly decline.

However, as we are all painfully aware, cases are now surging, hitting new records daily in states (primarily in the South and West) that had been relatively unscathed and had loosened restrictions — or had never really enacted or enforced them in the first place. In response, governors in those states have either added new mandates (masks anyone?) or reinstated some of those that were previously relaxed. For example, Texas, Florida and Arizona just re-closed their bars. In short, what looked like a steady path to the "end" of the pandemic a month ago is now a far more uncertain course. Understandably, this has spooked the markets and has raised the risk of a correction, but I believe that the underlying trend remains positive for a number of reasons.

First, the Fed has made it clear that there are still “more bullets in their gun” and that they will do whatever it takes to support the economy (and not so subtlety the stock and bond markets). Second, I think we’ve seen that wearing masks and practicing social distancing (especially avoiding large crowds where many are not doing either) can go a long way to reducing the spread. If these states follow the earlier path of the Northeast region, we will likely see cases begin to decline in a month or so. Importantly, most new cases are now among younger people who should require less hospitalizations. We have also improved treatment of the disease (deaths are still trending down despite the surge in new cases, though there is a lag to contend with) so strains on the hospital system should be less than earlier in the pandemic. In short, I think that the states will get things under control without shutting everything down again.

Shape Of Recovery Not Key

Won’t this slow the recovery? Yes, but it shouldn’t derail it. There has been a lot of ink spilled in debating whether the shape of the recovery will look like a "V," "U," "W," or more. However, Brian Levitt of Invesco researched the last three recoveries 1982-1990 (W-shaped), 2001-2007 (V-shaped) and 2009-2020 (U-shaped), finding that while all did well, the slower U-shaped recovery actually delivered the highest peak-to-trough annualized returns and lasted the longest.

There is ample evidence that a recovery is underway. In May, all four coincident indicators that the National Bureau of Economic Research uses to determine whether the economy is in a recession or a recovery/expansion rose versus April (though they were still horrible versus February). The recovery may be slower than originally expected, and will likely require further stimulus from Congress to bridge the longer recovery time, but it should continue and stocks should benefit. As noted earlier, we could get a correction given concern over the surge. If so, the tech sector (where our models are concentrated) held up better in the initial selloff and should continue to be a "relative" safe haven.

 — John M. Boyd