This time really is different
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No two recessions or recoveries are alike. This is important to remember when assessing where we are today as the economy recovers from the COVID-induced recession. Due to a tendency towards recency bias, comparisons are inevitably made between the current economic landscape and those from the most recent past. But the previous recession and recovery caused by the 2008 Global Financial Crisis bears little resemblance to the COVID recession and recovery.
During 2008, money largely flowed to banks and other big businesses to prevent the collapse of the world’s financial systems. Limited direct-to-consumer stimulus and unemployment benefits left the jobless with few options to make ends meet. A housing crash and tumbling stock market zapped the wealth of many Americans.
Recovery from the Global Financial Crisis was slow. It took six years for unemployment to reach 5%, which the Federal Reserve believed to be the “natural” rate of unemployment at the time. GDP growth dropped 2% in 2008 and another 2.4% in 2009. Post-crisis, it ranged between 1.5% and 3% per year.
This time is very different. Monetary stimulus was directed at consumers most likely to spend through increased unemployment benefits, targeted relief payments to small businesses, and direct-to-consumer stimulus checks for low- and middle-income earners. The Federal Reserve has been patient and consistent in its stance that rates will remain at zero for several years. Because of this, the recovery has been dramatically fast. Unemployment peaked at nearly 15% in the spring of 2020, then dropped to 6% by March of 2021, less than a year later. What’s more, the Federal Reserve estimates that unemployment will dip below 4% this year. Meanwhile, GDP growth dropped 3.5% in 2020, but the Federal Reserve Bank of Atlanta estimates a 6% GDP growth rate for the first quarter of 2021 and estimates GDP growth will top 2% per year for the next several years.
Money in the bank
A unique aspect of this recession compared to almost any other recession is that it abruptly halted consumer spending. As a result, consumer savings rates jumped dramatically as spending money became increasingly hard to do. Though unemployment skyrocketed, plenty of people kept their jobs and incomes, plus received government stimulus payments, and had nowhere to spend the money. BlackRock estimates that consumers have a built buffer of at least 12% of disposable income over the last twelve months. It’s also estimated that as of early March, US households had $2.4 trillion in savings.
Pent up demand
Consumer spending typically accounts for about 70% of GDP and, flush with cash, Americans are making up for lost time. According to a survey conducted by the New York Times, about 35% of respondents plan to spend or travel more in the next year than they do in a typical year, while 28% planned to spend more than usual at restaurants. Already, hotel bookings are on the rise, airlines are no longer blocking middle seats, and the CDC is lifting its year-long no sail order for cruises.
Retail sales growth has shown incredible strength—February saw year-over-year growth of more than 15%, for example—and moviegoers are back in theaters. “Godzilla vs Kong” earned nearly $50 million in the first five days of its theatrical release in early April, on par with the opening weekend take of 2019’s “Godzilla” theatrical release. This is despite limited capacity in theaters for many major markets.
Will a rising tide lift all boats?
The US stock market saw a swift recovery from 2020’s first quarter selloff. This is undoubtedly due to the vast stimulus pushed into the market, plus the Fed’s zero interest rate policy. The market continued its upward trajectory in the first quarter. For the year to date, the S&P 500 Index gained a whopping 6%. While it’s unlikely these big gains will continue through the rest of the year, the market outlook for the US economy is robust and the US stock market will benefit from that strength.
This rising tide, however, will not lift all boats equally. The post-Global Financial Crisis economy heavily favored a few stocks—domestic, large-cap, high growth stocks, particularly in the technology sector. For a decade, those stocks largely outpaced smaller cap and value-oriented names. While a typical market downturn would see a shift in leadership, the downdraft during the first quarter of 2020 continued to favor large technology stocks. Only when the news of the first vaccine approval was announced in November did that rotation begin. Since then, small caps have outpaced large caps and value stocks have outperformed growth names (see chart below). This trend is likely to continue. As such, a tilt away from large-cap growth stocks (technology in particular) can offer a better risk/return profile over the short to medium term.
Performance of Russell Indexes
Source: Morningstar Direct. Past performance is not indicative of future results.
A similar pattern of divergence in performance and valuations emerges when comparing the trajectory of domestic stocks to foreign stocks. Both the MSCI EAFE and MSCI Emerging Markets Indexes have trailed the S&P 500 Index in total returns over the last decade, leading to big valuation differences. A tilt to non-US stocks should enhance returns over a more domestically-leaning portfolio over the medium term. That said, in the short run, Europe remains behind the US in vaccinations, but once they catch up, growth will be robust.
Bonds have faced several challenges in 2021, the strongest being rising interest rates. The 10-year Treasury yield topped 1.7% during the quarter, pushing bond prices down, causing the Bloomberg Aggregate Bond Index to lose 3.4% for the quarter. Despite the headwinds, investors should not abandon bonds. Instead, a focus on diversifying holdings, rather than simply owning the Aggregate Bond Index, should enhance returns. Investors should hold several mutual funds or ETFs that invest across geography, credit quality, duration, and sector.
The table below details returns for major market indexes through March 2021.
|Total Return (%)|
|YTD||1 Yr||3 Yr||5 Yr||10 Yr|
|MSCI ACWI ex USA||3.49||49.41||6.51||9.76||4.93|
|MSCI Emerging Markets||2.29||58.39||6.48||12.07||3.65|
|BBgBarc Agg Bond||(3.37)||0.71||4.65||3.10||3.44|
Source: Morningstar. Past performance is not indicative of future results.
During the fourth quarter, all three value indexes outpaced their growth counterparts. While it may be tempting to take this quarter’s events as a sign that value is finally coming back, this wouldn’t be the first false start for value stocks in recent memory—2016, for example.
While value stocks might outperform in the short run due to the disparity in recent returns, it remains prudent to maintain a modest overweight to growth stocks for most investors. Given the long-term outperformance and the higher future growth prospects for growth stocks, investors in the early stages of their investing lives can especially benefit from this stance.
The Bloomberg Barclay’s Aggregate Bond Index is a broad based, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The MSCI ACWI ex US Index is comprised of non-U.S. stocks from developed markets and emerging markets.
The Russell 1000 Index is a broadly diversified index made up of top companies by market capitalization in the United States.
The S&P 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
The Russell 1000 Growth Index is a broadly diversified index predominantly made up of growth stocks of large U.S. companies.
The Russell 1000 Value Index is a broadly diversified index predominantly made up of value stocks of large U.S. companies.
The Russell 2000 Index is a composite of small cap companies located in the United States.
The Russell 2000 Growth Index is a composite of small cap companies located in the United States that also exhibit a growth probability.
The Russell 2000 Value Growth Index is a composite of small cap companies located in the United States that also exhibit a value probability.
The Russell Mid Cap Growth Index measures the performance of the mid- cap growth segment of the US equity universe.
The Russell Mid Cap Value Index measures the performance of the midcap value segment of the US equity universe.
The indices are unmanaged and does not incur management fees, transaction costs or other expenses associated with investable products. It is not possible to directly invest in an index.
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