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Markets & Research
U.S. Midyear Outlook: From recession to recovery
Jared Franz
Economist
Mark Casey
Equity Portfolio Manager
Claudia Huntington
Equity Portfolio Manager
KEY TAKEAWAYS
  • Expect a bumpy path for U.S. markets in 2020 as the economy comes back online, followed by a potentially more solid recovery in 2021
  • Recoveries have been longer and stronger than downturns
  • A great divide between winners and losers makes it a stock-picker’s market
  • It’s better to consider staying invested than sit on the sidelines

The decade-long economic expansion did not end with a whimper. The coronavirus brought it to a screeching halt.


U.S. gross domestic product (GDP) fell 5% in the first quarter, and a steeper decline is likely in the second. Consumer spending, which accounts for about two-thirds of the U.S. economy, slid 13.6% in April, the steepest decline on record.


More bad news lies ahead in the short term, starting with the tragic human cost. Historic unemployment will likely have a lasting impact on the economy, and many businesses are failing. The path to economic recovery will depend on the course of the virus and public health response, and stock markets may bounce around for an extended period until the economy finds firmer footing.


“The U.S. stock market appears to be priced for a quick economic recovery,” says Capital Group U.S. economist Jared Franz. “But I expect a more gradual U-shaped recovery with bumps along the way,” he explains.


When will near-term pain give way to long-term gain? “Over the next six months, we will see some challenges, and I expect consumer demand to remain sluggish for some time,” says Capital Group equity portfolio manager Claudia Huntington.


 “That said, my three-year view is very optimistic. I am seeing a lot of long-term investment opportunities present themselves in this environment.”


The chart shows U.S. GDP growth from the first quarter of 2019 through the first quarter of 2020, then depicts three potential recovery scenarios based on estimates from Capital Group U.S. economist Jared Franz. The first scenario, labeled as “not likely,” depicts a V-shaped recovery with a sharp acceleration of growth from the recession in mid-2020 and strong growth in 2021. The second scenario, labeled as “likely,” depicts a U-shaped recovery with a longer period of time in recession before more modest growth in 2021. The third scenario, labeled as “possible,” depicts a W-shaped recovery with peaks and valleys. All three scenarios indicate positive growth in the fourth quarter of 2021. First quarter 2020 GDP growth is the advanced estimate released by the Bureau of Economic Analysis on May 31, 2020. Sources: Capital Group, Bureau of Economic Analysis, Refinitiv Datastream.

Market recoveries have been longer and stronger than downturns


There will certainly be ups and downs, but veteran Capital Group equity portfolio manager Rob Lovelace believes it’s a matter of when, not if, we make it across this valley. “Because the slowdown was the result of government policy — not economic imbalances or rising rates ― we can see what recovery can look like when policies are relaxed,” Lovelace says. “And that to me is reassuring.”


Of course, when you’re in the middle of a downturn, it feels like it’s never going to end. But it’s important to remember that market recoveries have been longer and stronger than downturns. Over the past 70 years the average bear market has lasted 14 months and resulted in an average loss of 33%. By contrast, as measured by Standard & Poor’s 500 Composite Index, 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. After the carnage of 2008, for example, 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.


Long-term investors may take comfort in knowing that tough companies have often been born in tough times. Consider these examples: McDonald’s emerged in 1948 following a downturn caused by the U.S. government’s demobilization from a wartime economy. Walmart came along 14 years later, around the time of the “Flash Crash of 1962” — a period when the Standard & Poor’s 500 Composite Index declined more than 22%. Microsoft and Starbucks were founded during the stagflation era of the 1970s, a decade marked by two recessions and one of the worst bear markets in U.S. history.


Companies that can adapt and grow in tough times often present attractive long-term investment opportunities. Bottom-up, fundamental research is the key to separating these resilient companies from those likely to be left behind.


Chart showing a timeline of bull and bear markets from January 1945 through May 2020 with labels of notable companies that were founded near bear markets. The companies and year they were founded include McDonald’s, 1948; Medtronic, 1949; Hyatt, 1957; Walmart, 1962; Nike, 1964; Airbus, 1970; Starbucks, 1971; Microsoft, 1975; Apple, 1976; Adobe, 1982; AT&T, 1983; Gilead, 1987; Taiwan Semiconductor Manufacturing Company, 1987; Tesla, 2003; Facebook, 2004; Uber, 2009; and Zoom, 2011. Sources: Capital Group, Standard & Poor’s. As of 5/31/2020. The bear market is considered current as of 5/31/20. In all other periods, bear markets are peak to trough declines of at least 20%. Bull markets are all other periods.

The post-COVID market presents opportunity for selective investors


While the pain of the current downturn has been widespread, its impact has not been universal. With stores shuttered and consumers mostly sheltered at home, U.S. retail sales slid an unprecedented 16.4% in April, according to the U.S. Commerce Department. But that’s not the whole story.


A look beneath the surface of the U.S. stock market shows there has been a stark divide between winners and losers in this era of limited mobility. Not surprisingly, online retailers and grocers have enjoyed strong sales growth as consumers eat in and do their shopping in front of a screen. Providers of broadband, health care, home improvement materials and educational services have also benefited from healthy demand. Conversely, restaurants, travel and leisure companies, and aerospace companies have seen sales evaporate.


“We are witnessing a number of exciting themes emerge during this crisis,” says Huntington. “Within health care, for example, we are seeing telemedicine come to the forefront, as elements of the national health system go online, improving efficiency for many patients.” To be sure, not all companies will equally tap into rising opportunity, so selective investing will be critical going forward, Huntington adds.


The line chart shows sales growth for industries in the U.S. retail sector from 2005 through April 30, 2020. One line on the chart tracks sales growth for retail industries identified as COVID-resilient; the second line tracks sales growth for all other retail industries. COVID-resilient retail industries include e-commerce, health & personal care, grocery, alcohol and home improvement. Sales growth for the two groups generally follow a similar pattern from 2005 through 2014, but sales growth for the COVID-resilient industries begins to outpace the other industries after 2014. Data in 2020 shows a sharp rise in growth for COVID-resilient industries and a sharp decline for all others. A table inset in the chart shows one-year sales growth through April 30, 2020, for select industries. They include the following COVID-resilient industries: E-commerce, 22%; grocery, 13%; home improvement, 0%; and health & personal care, down 10%. The bottom four other industries include the following: restaurants, down 49%; electronics, down 65%; furniture, down 66%; and clothing & accessories, down 89%. Top and bottom retail industries do not include those that had not reported April 30, 2020 sales growth, as of May 31, 2020. Sources: Refinitiv Datastream, U.S. Census Bureau.

Digitization of daily life is here to stay


Some of the recent demand activity reflects an amplification of already established trends. Cloud demand, for example, was sky-high before the COVID-19 outbreak. But the events of 2020 have kicked that theme into overdrive. In the stay-at-home era, e-commerce, mobile payments and video streaming services have soared in popularity, occasionally pushing the limits of technology. While the levels of online activity are likely to moderate, the pandemic could be a catalyst for even stronger e-commerce growth in the years ahead.


“The response to the COVID-19 crisis — keeping everyone at home — has accelerated this powerful trend of digitizing the world,” explains Capital Group portfolio manager Mark Casey.


“Services that were already useful have in some cases become almost essential. Many people felt compelled to try grocery delivery for the first time, for example, and subscriptions to Netflix skyrocketed.”


There’s also room to advance, Casey adds. While e-commerce has grown in popularity, it still represents only about 11% of U.S. retail sales last year, and mobile payments stood at similarly low levels. “Given where we are now in the consumer-technology space, the growth potential is truly exciting.”


Don’t forget: A presidential election is looming


In an odd twist of political and economic fate, the event that everyone thought was going to be the biggest story of the year has been relegated to an afterthought. And maybe that’s the best way for investors to think about it.


That’s because, historically speaking, presidential elections have essentially made no difference when it comes to long-term investment returns. The U.S. stock market has powered through every election since 1933, reaching new highs over time regardless of whether a Republican or a Democrat won the White House.


What has mattered most is staying invested. Getting out of the market during election season has rarely paid off. It’s time, not timing, that makes the difference.


By design, elections have winners and losers, but the real winners have been investors who avoided the temptation to time the market and stayed in it for the long haul.



Jared Franz is an economist covering the U.S. and Latin America. He has 14 years of investment industry experience. Prior to joining Capital in 2014, Jared was head of international macroeconomic research at Hartford Investment Management Company and an international and U.S. economist at T. Rowe Price. He holds a PhD in economics from the University of Illinois and a bachelor's from Northwestern.

Mark Casey is an equity portfolio manager with 18 years of investment experience. He holds an MBA from Harvard and a bachelor's from Yale.

Claudia Huntington is an equity portfolio manager with 47 years of investment experience. She holds an MBA from Harvard and a bachelor's in economics from Stanford.


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