Markets & Research
Midyear Outlook: Recovery on the horizon
Rob Lovelace
Equity Portfolio Manager
Joyce Gordon
Equity Portfolio Manager
Mike Gitlin
Head of Fixed Income
  • Because this economic decline is policy driven, a solid recovery is likely as lockdowns end.
  • Easy monetary policy, aggressive fiscal policy and zero-bound interest rates should continue to support equity markets.
  • It’s not too late to upgrade your fixed income allocation as rates are likely to remain lower for longer.

In the opening weeks of 2020, investors had very few hints of the daunting events to come in this most unusual year. The U.S. economy was humming along nicely. Unemployment levels declined to 50-year lows. And the stock market hit record new highs almost like clockwork.

That was then. This is now.

Over three challenging months, coronavirus-induced lockdowns have wreaked havoc on the U.S. and global economies. Millions have filed for unemployment benefits. COVID-19 infections appear to have peaked in many places, but the risk of secondary outbreaks remain. Meanwhile, widespread civil unrest in many American cities has added a volatile new element to an already high level of uncertainty.

Despite all of this, many stocks are down on a year-to-date basis but not necessarily out as many investors optimistically look ahead to an eventual recovery. Their hopes are underpinned by massive government stimulus measures and ultra-low interest rates. Some companies perceived to be benefiting from stay-at-home mandates — including e-commerce, video streaming and food delivery firms — have rallied in the face of the worst market and economic environment since the 2008–09 global financial crisis.

As Capital Group vice chairman and portfolio manager Rob Lovelace has noted in recent investors calls, there is a unique aspect of this downturn: It was self-imposed by governments in response to a global health crisis. As such, it is not difficult for investors to imagine an end to this chapter and look forward to a post-COVID recovery period, which may have already started.

“This is different than the 2008 financial crisis — we can see the other side of the valley,” says Lovelace, a Capital Group portfolio manager.


 “It’s hard to know how wide the valley is, but I believe we will end up in a better place two years from now.”

Positioning for a market recovery

Bear markets are painful, no doubt about it. And when you’re in the middle of a sharp decline like the one we saw in March, it feels like it’s never going to end. But it’s important to remember that during the post-World War II era, bull markets have been far more robust than bear markets, and they’ve lasted considerably longer as well.

While every market decline is unique, over the past 70 years the average bear market has lasted 14 months and resulted in an average loss of 33%. By contrast, the average bull market has run for 72 months — or more than five times longer — and the average gain has been 279%.

Moreover, returns have often been strongest right after the market bottoms, as investors learned in the last severe downturn. After the carnage of 2008, U.S. stocks finished 2009 with a 23% gain. Missing a bounce back can cost you a lot, which is why it’s important to consider staying invested through even the most difficult periods.

The chart headline reads: Market recoveries have been longer and stronger than downturns. The chart shows cumulative price returns for Standard & Poor’s 500 Composite Index from June 13, 1949, to May 31, 2020, highlighting each bear and bull market. The cumulative total return of the average bull market was 279%, lasting an average 72 months. The cumulative total return of the average bear market was –33%, lasting an average 14 months. Sources: Capital Group, RIMES, Standard & Poor’s. The 2020 bear market is considered current as of May 31, 2020, and is not included in the “average bear market” calculations. In all other periods, bear markets are peak-to-trough price declines of 20% or more in the S&P 500. Bull markets are all other periods. Returns shown on a logarithmic scale. Returns are in U.S. dollars.

Dividends and the downturn

Another important difference in this downturn is that prospects for some dividend-paying stocks have changed dramatically. During previous bear markets, dividend stocks in aggregate have generally helped to provide a cushion against rapidly falling equity prices. Not so this year as many previously reliable dividend-paying companies have suspended or cut those payments in a bid to preserve capital.

However, rather than avoiding income stocks altogether, investors should instead consider the fundamental strengths and weaknesses of each company with an eye toward dividend sustainability going forward, notes Joyce Gordon, a Capital Group portfolio manager.

Indeed, select companies across various sectors — including Apple, Costco, Procter & Gamble and UnitedHealth — have actually increased their dividends this year. “The key is to be really selective in this environment,” Gordon says. “Not all dividend-payers are created equal. Companies with high debt levels and a deteriorating credit outlook are particularly unattractive, in my view.”

 The chart headline reads: In a low-rate world, dividends are more important than ever. This chart shows that in a low interest rate world, dividends can be an important source of income for investors. The lines on the chart show the 10-year U.S. Treasury yield declining from above 6% in 2000 to 0.7% in 2020. Also shown is the average dividend yield for companies in the S&P 500 Index, which has climbed from around 1% in 2000 to 1.9% in 2020. Sources: Refinitiv Datastream, Standard & Poor’s. As of May 31, 2020.

International outlook: Seek opportunities beyond borders

If you’re convinced that all the best stocks are in the U.S., then it’s time to take a closer look at the issue.

While it’s true that U.S. market indexes have generated greater returns than international indexes over the past decade, indexes don’t tell the whole story. In fact, on a company-by-company basis, the picture changes drastically: The stocks with the best annual returns have been overwhelmingly located in non-U.S. markets.

That trend was even more pronounced in the first quarter of 2020. The list of investable companies with the best returns was dominated by Chinese firms. Not surprising, given that China was the first country to get hit by the COVID-19 outbreak, and among the first to emerge from lockdown. While one quarter is a very short time frame, the trend has broadly played out over other years as well through generally smaller non-U.S. companies in fast-growing emerging markets.

Why? It’s all about opportunity set. There are roughly three times as many foreign stocks as domestic. So why fish in a smaller pond when there are great companies all over the world? When markets are uncertain, it’s important to have flexibility. Consider selecting global funds that give managers the ability to choose from among the best companies, no matter where they are located.

Fixed income outlook: Focus on core strength

Stock market turmoil has hammered home one crucial lesson: the importance of high-quality bonds in a diversified portfolio. If you owned a core bond fund that provided capital preservation and diversification from equities when the stock market plummeted in the first quarter, then you probably feel pretty good about your decision.

From peak to trough, equities fell more than 30%, while core bond fund returns — as measured by the Bloomberg Barclays U.S. Aggregate Index — were close to flat. By contrast, many widely used funds in the core plus and multisector bond categories, which often rely more heavily on higher risk bonds, failed to perform these critical roles and investment returns suffered.

“We talk all the time about the four roles of fixed income in a balanced portfolio. They are diversification from equities, income, inflation protection and capital preservation,” explains Mike Gitlin, Capital Group’s head of fixed income. “There is no fifth role for replicating equity risk across your entire bond portfolio. We believe investors should take measured risks in their equity portfolios and dedicate a large portion of their bond portfolios to those four very important roles.”

If you didn’t follow that approach, you might think it’s too late to upgrade your bond portfolio. It isn’t, Gitlin notes. Even though government bond yields have fallen sharply, the market expects them to remain low. Easy monetary policy, low growth and near-term muted inflation prospects imply that significantly higher rates aren’t a major risk today.

The potential shock absorption that a quality-oriented core bond fund can provide still matters. Stock market volatility may not be over. While many investors expect the global economy to recover eventually, the timing isn’t certain and, therefore, a solid dose of downside protection remains a vital part of any fixed income allocation.

 The chart headline reads: Does your fixed income need an upgrade? The chart shows that core bond funds have provided diversification from equities in recent periods of volatility. The graphic includes a pair of bar charts for each of the five largest equity market declines since 2009, including cumulative returns for the Bloomberg Barclays U.S. Aggregate Index (the core bond benchmark) and S&P 500 Index, respectively. These periods include the flash crash in 2010, U.S. debt downgrade in 2011, oil price shock from 2015–2016, the global selloff in late 2018 and the coronavirus crisis in 2020. In all periods, the Bloomberg Barclays U.S. Aggregate Index average sharply outpaced the S&P 500. Source: Morningstar. Dates shown are representative of the five largest equity market declines (without dividends reinvested) in the unmanaged S&P 500 with at least 50% recovery persisting for more than one business day between declines. The returns are based on total returns in USD. As of 5/31/20.

Rob Lovelace is vice chairman of Capital Group, president of Capital Research and Management Company, and serves on the Capital Group Management Committee. He has 34 years of investment experience, all with Capital. He holds a bachelor's in geology from Princeton and is a CFA charterholder.

Joyce Gordon is an equity portfolio manager at Capital Group with 39 years of investment experience. She holds an MBA and a bachelor’s in business finance from the University of Southern California. 

Mike Gitlin is head of fixed income at Capital Group. He has 25 years of investment industry experience. Before joining Capital in 2015, Mike was head of fixed income and global head of trading for T. Rowe Price. He holds a bachelor's from Colgate University.

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