- Market Insights
- 5 mins
This week's GDP report confirmed what all economists and investors already knew: that the economy is either already in recession or soon will be. The situation is unique not only because it is rooted in a public health crisis but, at a time when new developments occur daily, quarterly economic data are ancient history. We don't need to wait until July to know that the second quarter GDP number will be far worse or that next week's April jobs report will be eye-watering. What matters for long-term investors now is what happens going forward as we approach the light at the end of the tunnel.
The common definition of a recession is two consecutive quarters of negative GDP growth, although the official dates are determined by the National Bureau of Economic Research (NBER) using a range of data after the fact. This week's GDP report showed that the economy shrank by -4.8% in the first quarter when the economy was just beginning to shut down, the worst decline since the 2008 financial crisis. To put how abrupt this is in perspective, the first negative GDP quarter in 2008 was -2.3%, with five negative quarters in 2008 and 2009 overall ranging from -0.6% to -8.2%. During the tech bubble, the economy only shrank two non-consecutive quarters at -1.1% and -1.3% each.
What's more, the consensus estimate for GDP in the second quarter is -26% which would be the worst in modern history. Initial jobless claims have now surpassed 30 million since mid-March, compared to the 23 million jobs created since the global financial crisis. A whole host of other data, from manufacturing output to retail spending, have plummeted. Other regions around the world are experiencing similar problems with the Euro-area economy shrinking 3.8% in the first quarter. This is why the Fed is "using its full range of tools" and Congress has passed a variety of stimulus measures, alongside central banks and governments around the world.
The fact that we know why this is happening and that it may eventually pass doesn't make it any emotionally or psychologically easier to navigate as investors. There are a few facts worth remembering as plans to reopen the economy are formulated. First, the economy was fundamentally strong going into the crisis. This is not 2008 when the financial system ground to a halt due to its own excesses or 2000 when valuations were exorbitant. This time around, while stock market valuations were not cheap, growth had been slowing, and the cycle was already in its 11th year, the economy was still fundamentally healthy.
Second, COVID-19 cases in the U.S. appear to be plateauing, there are initial signs of possible treatments, and other countries have been able to open up. This suggests that, depending on how we navigate the public health considerations, there is the possibility that the U.S. economy can begin to reopen in the next couple of months. The fact that many of those counted as unemployed are either furloughed or can be quickly recalled back to work is positive. Of course, timing matters - being recalled to work in mid-May is very different from July - and not all sectors will rebound easily.
Third, although many investors naturally prefer for the stars to align in order to feel comfortable investing, markets simply don't wait for conditions to be perfect. The month of April, which has experienced an S&P 500 return of 14% so far and 31% since the March low, is evidence of this. While we should not overstate the importance of a single month, and investors should continue to expect a high degree of uncertainty, the point is that markets are forward-looking even when investors are not.
Thus, while it is challenging to do so in the middle of a crisis, it is important to focus on longer time horizons. Recessions and bear markets are a natural and unavoidable part of investing. In many cases, they allow the economy to shake off excesses and re-allocate resources, paving the way for future growth. In this case, it has reminded all market participants of the importance of public health policy. Once a crisis subsides, subsequent economic expansions and bull markets not only last significantly longer, but are the reason investors are able to achieve their financial goals.
Below are three charts that help to put recent economic data in perspective.
1. The economy shrank in Q1 by the largest amount since the financial crisis
U.S. Economic Growth
Find this chart under "U.S. Economy"
The economy shrank by 4.8% in the first quarter of the year, the worst drop since the 2008 financial crisis and the early 1980's before that. The economic shutdown that drove this number didn't truly take effect until the second half of March. Thus, it's widely expected that the Q2 numbers will be much worse.
Since this is already well understood and expected, it's important for investors to look ahead. If businesses can responsibly reopen in the coming months, then economic growth can begin to recover.
2. The business cycle was already in its 11th year
U.S. Business Cycles
Find this chart under "U.S. Economy"
The business cycle was in its 11th year before the coronavirus crisis, having begun in mid-2009. Not only was this last economic expansion the longest in history, but it grew at a steady pace. The fact that the economy was healthy entering the crisis increases the likelihood of a recovery.
3. Recessions and bear markets are a natural part of long-term investing
Stock Market Cycles
Find this chart under "U.S. Stock Market"
Long-term investors will inevitably face many ups and downs over the course of their lives. It's important to keep this in perspective and focus on what truly matters: achieving financial success over the long run. While many investors would prefer for conditions to be perfect, the reality is that this isn't a necessary condition to achieve healthy returns.
