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Equity markets dropped on Thursday (June 11) as fears of a second wave of COVID-19 infections and doubts about a speedy economic recovery dampened investor sentiment. Stocks are on pace to decline the most in over a month with cyclical sectors underperforming and bonds rising.
While today's market moves are sizable, they should be framed in the context of the recovery witnessed in prices over the last few months. Since the March 23 bottom, the S&P 500 has risen 34%, while volatility has subsided.* In our view, a longer-term economic recovery is underway, but a lot of uncertainties remain, likely triggering periodic setbacks along the way.
Virus path remains uncertain – The rate of new, confirmed coronavirus cases in the U.S. peaked in mid-April and, while still elevated, has steadily declined since, supporting investor confidence. However, a lot of that improvement has been driven by a deceleration in cases in former hot spots such as New York and California. At the same time, there has been an acceleration of infection cases and hospitalization rates in a handful of states leading the reopening, such as Arkansas, Arizona and Texas.
Since the trigger for this crisis is biological rather than financial, progress on the medical front will play a key role in the shape of the recovery. Even though there have been some initial signs of success in human trials of a COVID-19 vaccine, this development remains uncertain. In addition, the likelihood of a second wave of infections could constrain economic growth.
Fed warns economy faces a long road to recovery – The Federal Reserve reiterated on June 10 its pledge to keep rates near zero until the economy has weathered the crisis, with most Fed officials projecting rates staying near zero through 2022. The Fed also updated its quarterly economic projections, showing a steep GDP decline this year followed by a gradual recovery. Unemployment and inflation are forecast to recover over the next two years but remain below the long-run trend.
The committee's caution on the economic outlook clouded some hopes for a speedy recovery, suggesting a long road ahead. Our view is that a gradual economic recovery is underway as the economy slowly reopens. However, given the magnitude of the downturn, it will likely take several years for economic activity to reach pre-pandemic levels.
Setting realistic expectations – The speed and aggressiveness of the rebound in stocks imply that expectations about an economic restart might be somewhat optimistic. We believe the path for the markets in the second half of 2020 will likely be bumpy as periodic setbacks stoke volatility. However, higher volatility doesn’t necessarily mean a repeat of the conditions we experienced in March, which were fueled by extreme uncertainty around the pandemic, the policy response and the duration of the lockdowns.
There are still plenty of uncertainties and unknowns, but ultimately, an economic recovery will take shape, in our view. Investors should consider rebalancing opportunities and systematic investing at regular intervals, which can reduce the “timing” aspect as volatility plays out.