The global economy and markets are dramatically different today than they were when the year began. Just a few short weeks ago, the Federal Reserve Bank of Atlanta was tracking first quarter 2020 U.S. GDP growth at a 3.1% annual rate. Today, our base case is that the U.S. economy is likely entering a period of recession that is likely to extend over the next few quarters. COVID-19 has caused a shock not seen since the financial crisis of 2008 and its impact will be significant. However, unlike 2008 when the bursting of the housing bubble and related bank failures threatened the entirety of the global financial system, we believe COVID-19’s negative economic effects will be transitory, and that global growth should reaccelerate toward the back half of 2020, perhaps as soon as during the third quarter.
Looking back at a past pandemic for partial context, the Asian flu pandemic of 1957 hit the U.S. in late 1957 through early 1958. According to the Centers for Disease Control (CDC), the Asian Flu killed almost 70,000 people in the U.S. and didn’t spare younger people as much as COVID-19 appears to. Real GDP was growing around 3% annually in 1957, but as the flu started to peak in the fourth quarter of that year, the economy shrank at a 4.1% annual rate. This was followed by an annualized 10.0% plunge in the first quarter of 1958, the deepest drop for any quarter since World War II. But subsequently, the economy rebounded at a 7.8% annual rate for the next five quarters.
No one knows with any real certainty how much, or for how long, COVID-19 will impact the U.S. economy, but we do know that the U.S. economy, bank and household balance sheets were relatively strong prior to this shock. Additionally, government policy makers have the tools at their disposal to help stabilize market sentiment. Policy can target three interrelated areas in the face COVID-19: 1) Prevent a sustained tightening of financial conditions, 2) Stave off cash flow disruptions that would threaten to shutter otherwise sound businesses, and 3) Support households whose incomes have significantly eroded as the result of the shock. We see a need for decisive policy response across these dimensions to safeguard the economy and the markets.
What we are looking for is concerted effort to coordinate public health, monetary, fiscal and liquidity policies to help alleviate uncertainty. Unfortunately, we do not yet have all of these in place. It is our view that the current lack of comprehensive policy initiatives is exacerbating the selloff and increasing the negative volatility. We believe these will eventually come and that they will set the scene for a strong rebound. We’ve had several, consequential health crises in our history, and while the human impact is very real, from an economic perspective all have been temporary and all were followed by a strong economic recovery.
As previously mentioned, the markets are now appropriately pricing in both a recession and steep drop in corporate profits. This is now the base case scenario and our current portfolio positioning is appropriate in this regard. As indiscriminate selling pressure intensifies, we are also seeing long-term opportunities. Strategically, we are preparing to rebalance client portfolios, but are waiting for signs of stabilization. Internal market metrics are beginning to suggest capitulation, but without corresponding fiscal policy, we prefer to remain on the sidelines in the name of risk management. We will continue to keep you up to date as events unfold.