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Economic Outlook

Source: FRED, United States GDP growth, quarter over quarter percentage, seasonally adjusted.

The economic shock from the Covid-19 containment measures we expect will produce the sharpest decline in GDP that we’ve seen in nearly a century. As painful as that is, we think the nature of the downturn and the rapid policy responses offer the potential for a faster rebound than normal.

Virus containment drives an historic slowdown – This recession emerged almost instantly as social distancing measures brought consumption to a sudden stop. We think GDP will contract at the sharpest quarterly rate in nearly a century, likely declining by more than 20% in Q2. For comparison, the worst quarter in the financial crisis was an 8.4% decline in Q4 2008.

Labor market holds the keys – Recent weekly readings of initial jobless claims have surged to unprecedented levels, heralding what we believe will be a dramatic surge in the national unemployment rate in Q2, potentially as high as 20%-30%. This compares with peaks of 10% in 2009, 10.8% in 1982 and 9% in 1975. While the current surge in unemployment will be painful, we think Washington’s fiscal rescue package will be critical in preserving conditions for payrolls to return to healthier levels in much more rapid fashion.

Potential for a vigorous rebound – We think the path ahead for the financial markets will be dictated more by the duration of the economic shutdown than the magnitude of the GDP decline. In our view, a severe but somewhat temporary contraction is already priced in to financial markets. Progress in containing the spread of the virus will dictate the timeline, but we think the nature of this shutdown (self-imposed versus structural weakness in the economy), combined with significant fiscal and monetary policy stimulus, sets a compelling stage for a potentially faster-than-average rebound later this year.

Action for investors

We believe a recovery will take shape, supporting performance in more cyclical asset classes such as small- and mid-cap equities. U.S. large-cap equities and investment-grade bonds appear suited to navigate the current economic challenges. More defensive sectors and companies with the strongest balance sheets also offer opportunities to position portfolios.

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