05.08.20
Prudently optimistic: A look ahead to the rest of 2020
As economies and markets worldwide continue to reel amid the economic uncertainty surrounding the COVID-19 pandemic, John Canally, CFA, Chief Portfolio Strategist for TIAA's Investment Management Group, shares his insights on where we’ve been, what to expect going forward and how election year politics may influence the markets and economy in the months ahead.
Q. John, what are the markets most concerned about right now?
A. There are four key areas we’re focusing on now where the markets want to see progress. These include monetary policy, fiscal policy, market functioning and liquidity, and health and safety. We’ve actually graded each of these green, yellow or red based on how the markets have priced-in recent government actions and policy decisions.
Q. You’ve given both monetary and fiscal policy a green light. What
was your assessment based on?
A. The markets are really happy with what’s taking place relative to monetary policy. We’ve seen a commitment from the federal government to do “whatever it takes” to assist the economy during the COVID-19 quarantine through tax cuts and spending increases. In fact, the Federal Reserve (the Fed) has done more to support the markets and economy in the six-week period through April 15 of this year than it did the entire three years of the global financial crisis in 2007-2009. So this continued financial support we’re seeing for the financial markets, large and small businesses, and individual households is really critical during this unprecedented time.
Q. How does this compare to actions taken during previous downturns?
A. The historic context is really important. In the early 1930s, during the Great Depression, we saw the Fed raise rates. This time, not only did they not raise them, they actually cut rates to zero. So we’ve seen very swift action, with a massive amount of quantitative easing within a six-week period to support different areas of the markets and economy.
Congress also did more to support the economy via tax cuts and spending increases in March 2020 than it did during the entirety of the 2007-2009 financial crisis. When we look at the early years of the Great Depression, between 1929 and 1933, there was no unemployment insurance or fiscal stimulus at all. The only thing Congress did was raise tariffs, which actually made things worse. This time Congress has acted swiftly, passing a $2.2 trillion stimulus package within a month of the start of the crisis here in the United States to help support small business and consumers.
Q. You’ve given ‘market functioning and liquidity’ a yellow light. Why is that, and what will it take to get a green light?
A. Market function is critical. The first thing we want to know is: Are the markets trading? Are sellers and buyers coming together in the stock, bond and commodities markets? We’ve graded this one yellow because there’s still a few areas that are not functioning, but for the most part, they are. We’ve seen the Fed come in to help, and the Treasury has helped to backstop many of these markets so that they function better. Again, these are things the Fed did really quickly this time versus the 2007-2009 downturn, where it took them a couple of years—or during the Great Depression, where they didn’t do anything.
The good news is that the financial markets and the banking system are now functioning close to where they were in early 2020. So, we’re prudently optimistic here.
Q. Health and safety get a red light. What are your concerns in the weeks and months ahead?
A. Before this one can go from red to yellow, we need to see a continued decline in hospitalizations related to COVID-19, along with increased availability of testing. A green light really depends on the introduction of new drug therapies to combat the symptoms of the virus and/or an FDA-approved vaccination to safeguard against getting the virus. So we’re watching progress on the health and safety front very closely and looking ahead to how the economy will reopen and what that will look like.
Q. A lot of investors are wondering why the markets are rallying amidst all the bad news on the economy and the health front. Why is that happening?
A. The simple answer is that the markets are really a discounting mechanism, so they’ve already discounted a lot of the bad news and are looking ahead to 2021.
When the markets fell roughly 35% between mid-February and March of this year, they priced in a lot of bad news, including a severe recession. They had also priced in the bad news we saw in late March and early April on the health front, including increased hospitalizations and deaths due to COVID-19, business shutdowns, lay-offs and rising unemployment.
Right now, the markets are rallying because they see a path to reopening and restarting the economy, with the assumption that we’ll be back to a somewhat normal state by 2021.
It’s also important to remember that when we entered this period, the economy was in good shape. So heading into the downturn, there were very few imbalances. We weren’t seeing individuals borrowing against their homes like we did heading into the Great Recession in 2007, and businesses weren’t overleveraged or saddled with debt.
In the period leading up to the global financial crisis in 2007, and the Great Depression in the 1920s, there were an extreme number of imbalances in the economy. That’s not happening now.
Q. What about the banking system? Should people be worried?
A. Heading into the Great Depression, as well as the 2007-2009 financial crisis, the health of the banking system was very poor. Following both of those difficult periods, regulations were introduced requiring the banks to adhere to strict guidelines. We’re seeing the guidelines that were put in place 10 years ago paying off today. So our banking system is in good shape to weather the storm we’re facing now.
Q. A lot of people want to know if we’ve seen the bottom of the market yet.
A. The important thing to understand here is that bottoming is a process, not an event. That’s among many reasons why you don’t want to try to time the markets. For example, during World War II, the stock market bottomed in April 1942. However, the war didn’t end until September 1945. So there were three years of invasions, bombings and a rising death toll yet to come. However, the market had already factored in much of this bad news three years earlier, in 1942. The historic view is important as people try to make sense of where we are today. We saw a similar pattern during the 2007-2009 financial crisis. Stocks bottomed out in February and March of 2009, and the economy officially hit bottom in June 2009. The economy didn’t get back to its prior peak until 2011. So historically, we know that markets tend to bottom well before the worst news of the curve, which is why markets appear to be rallying now, in the middle of bad news.
It’s important to understand that reaching the market bottom will happen over the course of time as events unfold. We have to have some certainty around when the economy is going to reopen, how it reopens and if we can sustain that. Will we have the testing capacity we need? What about drug therapies? How soon will be a vaccine be released? All of these questions feed into the bottoming process and what the recovery will look like.
Q. When do you expect we’ll see a turning point?
A. In today’s crisis, that moment may occur when an effective treatment is approved to treat coronavirus symptoms or once a vaccine is available. The market realizes that this is going to happen, it’s just a matter of when and how quickly.
Q. What’s the most likely scenario for a recovery? What will that look like?
A. There are several possible scenarios. An “L”-shaped recovery means we head straight to the bottom and stay there for a while, over the next few quarters. I think this one has a relatively low probability. Another scenario would be a “U”- or “V”-shaped recovery. In a “U” recovery, we remain at the bottom for a short period, then see a rapid and sustained rise. To achieve a “V”-shaped recovery, we’d have to see very rapid progress in the release of drug therapies or a vaccine.
While a “U”- or “V”-shaped recovery are both possible, it’s not likely that we would go from a place where the economy is really bad in March and April, and people are sheltering in place, to one where we open the full economy and spring right back to where we were before.
The more likely scenario, based on what we know today, is a “W”-shaped curve. The likely scenario is a rolling reopening of the economy where we see promising results on drug trials and the availability of widespread testing and contact-tracing capabilities. That would naturally lead to some starting and stopping based on an uptick in cases in different geographic regions that require locking down parts of the economy again. The "W"- shaped recovery would also be consistent with the potential of a second wave of COVID-19 cases re-emerging in the fall of 2020, along with the onset of the usual seasonal flu season.
Q. You mentioned ‘timing the markets.’ Why do you advise against this?
A. Market timing is when you move your money in and out of the markets or individual investments to try and capture the performance highs and avoid the lows. It’s really difficult, if not impossible, for any of us to time the markets with any accuracy. That’s why we like to say, “time in the markets is preferable to timing the markets.” Here’s a good example of why. From January 1 through April 29, 2020, the S&P 500 was down 9% for the year. However, if you missed the five best days of the market’s performance in 2020, you’d be down 40% as of April 29. That’s something to think about if you’re looking to go to cash or have money on the sidelines and you’re waiting for the “all clear.” You’re never going to get an “all clear” where the markets are concerned.
Q. Do you believe we’re in a recession now? And, if so, when do you expect it to end?
A. The simple answer is, yes, in my opinion, we’re in a recession now and it’s going to last awhile. But it’s entirely possible that it won’t officially be declared a recession until we’re out of it. That’s because there’s a lengthy process, whereby academics at the National Bureau of Economic Research pore over reams of information and data before they can officially label it a recession.
While the recession began in March, it’s possible that they may not tell us we’re in a recession until late this year. The same is true for when we’re on the other side of it; they won’t tell us it’s over until about a year after it’s ended. So, you don’t want to become fixated on when a recession starts or stops—the focus should be on the impact the markets are having now. If you’re simply waiting for a signal that the recession is over and it’s safe to get back in, that’s not a good investment strategy. To remain on track toward your goals, you need to remain focused on the long term.
Q. We’re hearing a lot about the impact the pandemic is having on the markets and economy. We’re also in an election year. To what degree will election year politics influence the markets or economy in the months ahead?
A. In a typical election year, the markets don’t tend to pay much attention to the elections until after the conventions. Normally, from late August through November, the markets will trade sideways to down, because there’s uncertainty about who may win. Once the results of the election are in, markets generally rally between Election Day and year-end. This year, of course, is a little bit different. With the unprecedented pandemic, a lot of the typical election year thinking has gone out the window. We’re also dealing with a recession, which is rare in an election year. In the last 60 years (1960-2020) recessions occurred during presidential election years just three times—1960, 1980 and 2008.
Q. Finally, what should investors be thinking about now as they plan for the weeks and months ahead?
A. It’s really important to remember that no one can predict with certainty what the market will do going forward. We’ll continue to see ups and downs in the markets in the weeks and months ahead. We could also experience a hiccup if we don’t see progress toward a vaccine, or if certain areas of the country or economy open up too fast and have to close down again. So you want to make sure that you continue to focus on your long-term goals. That means ensuring your portfolio is well-diversified. To manage risk, your portfolio assets should be spread out among a variety of investments, so that an upswing in one investment may help to offset downward movement in another as market conditions change. While not a guarantee, generally, a mix of asset classes that may include stocks and bonds has historically offered growth and a degree of stability over the long term.
There are a few other things you want to look at as well, such as rebalancing your portfolio if the current volatility in the markets has caused it to be misaligned with your target allocation. Also consider if there are opportunities to manage your investment-related tax bill through tax-loss harvesting. These are all areas where your TIAA wealth advisor can help.
For additional help and insights for staying the course toward your long-term goals, including steps you can take now, contact your TIAA advisor today to schedule time to talk about your needs and concerns. While we can’t meet in person, we’re here to help and are only a phone call away.
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This material is for informational or educational purposes only and does not constitute investment advice under any securities laws. This material does not take into account any specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on the investor’s own objectives and circumstances.
Advisory services are provided by Advice & Planning Services, a division of TIAA-CREF Individual & Institutional Services, LLC, a registered investment adviser.
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