2020 Fall Economic Forecast

The coronavirus pandemic sent the financial industry reeling, sending the S&P 500 to drastically drop in late March more than 30 percent from its previous year high in February. But Wall Street rallied and pulled its year-to-date percentage back to even by June, and has been holding steady since. This year has been an unpredictable ride for the market. Nevertheless the Business Times has asked four industry experts to share their thoughts and predictions on where this financial roller coaster goes from here.

By Chris Officer

Staff Writer

1) Amidst all of 2020’s volatility—and given the current state of the market—what should be an investor’s approach?

Bristol: Concerns are mounting that the U.S. election results may be uncertain after election day—and investors hate uncertainty. 

While it’s worth acknowledging the risks associated with a messy election outcome, we encourage investors not to overreact, and stay focused on your long-term financial plan. Staying invested, even during bouts of volatility, is crucial for long-term success. Being proactive in your portfolios may include diversifying risk exposures or making tactical tweaks to portfolios depending on the environment.

Consider hedging strategies for protection, which can be like an umbrella when markets get volatile. It may offset the impact of losses in other areas of your portfolio and can also provide peace of mind to help you stay invested.

Have dry powder on hand. Long-term investors could find buying opportunities if a contested election sparks a selloff in risk assets. Think about a potential “shopping list.”

Review portfolio allocations. As certain areas of the market have rallied off the coronavirus-crisis lows, it may make sense to ensure you have asset bite sizes that are appropriate for your specific goals, as well as your ability and willingness to take risk. 

In addition, we suggest you consider which parts of your portfolio may have outsized exposure to potential policy changes associated with the various outcomes.

Frigon: Our nearly four decades of professional market experience convince us that investors are best served by focusing on businesses rather than on markets. That means taking the time to do thorough and ongoing analysis and research on specific companies, talking to their management teams, monitoring their filings and their press releases and their quarterly earnings reports.

If investors don’t have the time or inclination to do that, then they are just gambling ­­with rather predictable and likely results.

Lowenstein: We have witnessed a global pandemic and the worst quarter for global growth on record. Those unique emergencies produced the highest levels of government and central bank support ever seen. And beyond these obvious extremes are the daily disruptions that remain impossible to ignore.  While always tempting to claim this time it’s different, the reality is that markets and the economy are highly resilient, adaptable and are prone to renewal over time once the event risk is behind you, and the healing process is underway. As investors, we need to look through the windshield not the rear view mirror as we position for the future.

The optimal approach for investors amid these unique times is to have a long-term plan and objectives, and a repeatable investment process tied to your goals that takes advantage of prevailing market conditions, underpinned by broad diversification across asset classes, opportunistic rebalancing, and allowing the power of compounding work its magic. Ironically, the best returns often appear when volatility peaks and market anxiety and uncertainty is high – this environment often produces ideal asset value miss-pricings. 

Don’t let the 24-hour news cycle, outside exogenous shocks, or market gyrations from fear and pessimism derail your underlying competitive advantage which is a patient, opportunistic, long-term approach. It helps keep you grounded when inundated with heightened market volatility and unexpected events which can dislocate markets from time to time. It’s mission critical to invest through uncertainty, prepare for unforeseen challenges, and seek out opportunity and avoid undue risks in times of change and naturally occurring market dislocations. 

Seek to constantly grow, learn, and gain perspective on market history, economic cycles, investor behavior and psychology. And don’t forget the old adage, in the short run the market is a voting machine, however, in the long run, it’s a weighing machine. 

Madlem: Be cautious but not fearful. Thoughtful and not reactive. Yes, we are living in a period of absolutely crushing and repressive forces, throwing a bewildering, simultaneous mix of blows to the consumer, the markets and society, but it’s not difficult to find a glass-half-full perspective. Compared to the dire predictions early on, this year has been full of upside. Most notably, predictions of tens of millions of global deaths from COVID, and millions in the U.S., have proved to be ridiculously over-wrought. 

The economic carnage has also turned out to be not nearly as horrific as feared. In early spring, many analysts were looking for a -40 percent contraction in U.S. real GDP for 20Q2. Estimates of -50 percent were not uncommon. Instead, the damage stands at just -31.7 percent. That is the worst quarter ever, but not nearly as bad as it might have been.

On this front, the U.S. has outperformed much of the rest of the world, e.g., the EU contracted -40 percent annualized and the UK -60 percent last quarter. Moreover, the upside economic surprises have continued. From the onset of the outbreak, We have expected a robust rebound, on the order of +25 percent real GDP. Now, we are tracking a +31 percent jump this quarter.

Consumption, of course, is the key driver. After plunging -7 percent in 20Q1 and -24 percent in 20Q2, consumption is headed for a +38 percent jump in 20Q3.

Housing has been a particular bright spot: real residential investment will likely be up +25 percent annualized this quarter as buyers retrace pent-up demand from the spring and then some. The equipment sector, which even two weeks ago looked to be in ominous shape, is now headed for a double-digit gain this quarter.

To be sure, there is a lot more ground to make up, but it will happen relatively soon. We continue to expect a new peak in real GDP by mid-2021. Most individual sectors will catch-up soon after. As always, the labor market will take noticeably longer to fully recover.

2) How will the market respond to a vaccine; moreover, how will it react if social sanctions drag on? 

Madlem: I think that the consensus view here is that, over a medium-term horizon, the status of a vaccine, the economic recovery, and Fed policy will be more important in determining equity valuations than anything else, including the outcome of the election.

But this assessment overlooks two factors. First, this downturn was caused directly by policymakers ordering the economy to shut down. As the 50 state governors began reversing their edicts, the economy began springing back. Second, businesses have been working around those restrictions. From restaurants developing take-out fare or turning parking spaces and side streets into “outdoor dining” to firms figuring out how to do more remotely, businesses and entrepreneurs have scrambled to keep going, mostly without government direction.

Before governors started mandating masks – when Dr. Fauci and the CDC were advising the public not to bother with masks – people were scrambling to find or sew those coverings. The government, incidentally, did not command people to use hand sanitizer obsessively and carry their personal spritzers everywhere, but a huge number of people have been doing it anyway.

Accordingly, despite the fears of many pundits that the public would remain paralyzed and “locked down,” most are anxious to return to normal life – and a normal economy – as fast as they can. That resilience is why the economic recovery will be sustained and why COVID-19, vaccine or no, will fade into the background over time. 

Lowenstein: Discovery of an effective and safe vaccine will be a game changer with respect to building confidence to fully reopen the economy and regain our full potential. Operation Warp Speed is a public sector and private sector collaboration working to provide critical funding, reduce regulations and fast track the vaccine approval process to bring to vaccines to market at record speed. We expect many vaccines to be approved later this year and early next year. The key challenge is ramping up enough manufacturing capacity, coordinating logistics to distribute broadly and proper storage availability. 

It’s still unclear what the uptake will be by the public given the unproven nature of the vaccine process and unique challenges the COVID virus presents. The good news is that COVID doesn’t seem to mutate as fast as the seasonal flu – the flu vaccine is only ~50 percent effective each year largely due to fast mutations – so scientists believe we can catch up to it and target it more accurately. 

Both vaccine effectiveness and transmission of COVID even after vaccination will be crucial. In all likelihood, early doses will target the most vulnerable, as well as front line health care workers and first responders. A vaccine combined with treatment options now available for severe symptoms will reduce mortality rates and build confidence in a quick resumption to normalcy. 

We know much more about COVID today than we knew early on. In hindsight, early protocols may not have been all that effective and were potentially counterproductive, such as early use of ventilators when blood oxygen levels dropped abruptly. This disease is as much of a cardiovascular disease as it is a respiratory disease and many of the unfortunate fatalities were from our own immune response going into overdrive fighting the virus rather than the virus itself. The good news is our paradigm has shifted and we have a broad array of tools to counter severe symptoms such as anti-virals, plasma treatments, steroids, monoclonal antibody cocktails, and anti-inflammation treatments. 

Despite the innovation and advances, COVID likely will be with us for a while until herd immunity is reached, either through hitting critical mass on infections or a mass vaccination effort is successful.

Frigon: Again, we have absolutely no interest in predicting markets, especially on a short-term basis, and we recommend investors not try to do so either. It is worse than a waste of time–it is actually detrimental to good investing and to achieving good investment results over a long period of years.

Bristol: We don’t think the recovery needs a vaccine to continue, but there are two sides to the vaccine coin—what it means for health and human safety and what it means for the macro and market environment.

Equities seem to be pricing in more vaccine optimism than fixed income markets—bond yields are at or near record lows across the curve as the Fed keeps rates low as a result of the virus fallout. 

While biotech stocks as a whole are reflecting some vaccine optimism (proxied below by future sales growth expectations), much of their recent stock price gains can also be attributable to a lower cost of capital, thanks again to the Fed’s lower for longer interest rates. 

Even so, other potential sectors that would benefit from a clearer outlook for growth following a vaccine—like airlines, real estate, hotels and leisure, and energy—are all still expecting weakness ahead.

With a deployable vaccine solution, infection curves have a greater chance of falling consistently, economic lockdowns and social distancing policies grow less necessary, and by extension, economic activity and growth have a clearer road ahead. With that also comes the possibility of stronger corporate earnings and a steeper yield curve as investors grow more confident in the future.

3) What are the implications of the Fed’s lower-for-longer approach to interest rates? 

Bristol: Politicians and policymakers around the world are working hard to get the economy back on its feet as lockdown restrictions continue to ease. The measures include huge government relief packages designed to provide temporary relief to workers and businesses. 

Meanwhile, central banks are supporting financial markets with massive bond-buying programs and record low interest rates. Inflation is likely to remain subdued–the risks are real, but shouldn’t be exaggerated. With interest rates so low, growing government debts do not appear to pose an imminent threat to their ability to service their obligations. 

We also believe the stimulus measures will not push up inflation materially and that prices throughout the economy are more likely to fall than rise.

Refinancing an existing loan or borrowing to enhance investment returns are just two strategies you can use to take advantage of the current environment. 

Given the current low cost of borrowing, adding capital through modest leverage is a compelling way to meet a range of personal and business objectives – including reducing repayments on an existing loan by refinancing, hedging any liabilities and enhancing potential investment returns.

Frigon: The Fed controls monetary policy, and Congress controls fiscal policy– it’s a mistake to think that you can steer an economy through Fed monetary policy. 

Monetary policy primarily impacts banks and their profit margins. Lower rates are interpreted as an attempt to stimulate the economy but that is a very inefficient and ineffective way to go about it. 

Usually Fed attempts to steer the economy end up doing more harm than good. Investors need to find companies led by competent management teams, and trust those management teams to navigate their businesses through the often-mistaken gyrations in Fed policy.

Lowenstein: The market really under appreciated the significance of the Fed’s policy shift in abandoning inflation concerns in favor of full employment. Upon reflection, it was subtle on the surface, but quite profound underneath.

The Fed is acknowledging that the Phillips Curve, which has guided Fed policy for decades, is broken, and the trade-offs between full employment and inflationary pressures are no longer in effect. On balance, this will allow for more accommodative policy for the foreseeable future and is a positive tailwind for growth, as the Fed will let the economy run hotter and won’t pre-emptively tighten lengthening the economic cycle, and risk assets, as lower rates benefit corporate profits and drive higher warranted valuations. 

Secular challenges to the growth outlook remain, including lower workforce participation, lower productivity and high debt levels. We expect real GDP growth to be ~1.5-2 percent this cycle vs. 2.2 percent last cycle. The specter of higher rates on the short-end has been diminished for now. However, at any moment the bond vigilantes could wake up from their decade long slumber and demand higher interest rates as compensation for higher risks. Our guess is if long rates move too high, too fast, the Fed will implement a form of Yield Curve Control to cap the level of interest rates and minimize the damage. 

Madlem: This is actually a question that clearly focuses on the grand experiment in which we are all the subjects. It was the Fed’s suppression of borrowing costs, and its willingness to curtail Wall Street’s occasional selling tantrums, that compromised the U.S. economy’s financial integrity. Sudden interest rate movements related to the price or perceived value of bonds, and the effects of historically low discount rates on equity valuations purely reflect the level of confusion facing global investors as we all circle the musical chairs.

The degree of speculation, overvaluation and mal-investment in today’s markets as about as bad as it’s ever been.

And the blame must be laid directly at the feet of the Fed and global central banks, who collectively employ intervention to suppress interest rates to their lowest levels in all of recorded history: This has resulted in all manner of unnatural distortions that warp and hollow out our economy and social structure.

Investors seeking income must now take imprudent risks. If 2 percent rates invited trouble, zero percent requires it. Not only do 0 percent interest rates act as “molasses” on growth by gumming the system up with zombie institutions and toxic mal-investment, but it imperils the social good.

Savers and investors, increasingly desperate for yield, are forced to accept worse and worse choices in attempt to stay afloat. This leads to greater and greater volatility in all aspects financial..

Under this regime, the rich benefit disproportionately at the expense of everyone else AND it creates a “hyperinflation in the cost of retirement”. This accelerating war on the 99 percent cannot stand for much longer without serious consequences and repercussions. 

4) What industries have the potential for some explosive growth stocks? 

Madlem: Here’s a partial list of rapidly growing transformative industries that cannot be ignored: Digital wallets, cybersecurity, renewables, genomics, alternative energy, ESG and impact investing (more of a philosophical, sustainable investment approach), intelligent transportation systems, and Blockchain. 

Lowenstein: There are many big secular themes to watch unfolding this cycle with an expansive runaway to continue into the foreseeable future. Some of the big trends as part of the overarching age of disruption and disorder include: digitization of the economy, artificial intelligence, automation and robots, electric vehicles going mainstream, work from home, 5G telecommunications rollout, Internet of Things, deglobalization, domestic manufacturing re-shoring, climate change polices, ESG investing goes mainstream, Cold War 2.0 between U.S. and China, rising populism and matching policies, millennials and Generation Z overtaking the baby boomers demographically, government’s outsized role in shaping the economy and markets, Modern Monetary Theory (monetized fiscal deficits may be closer than you think), and heavy government debt-burden impacting our growth potential.

Frigon: Now this is the question that investors should spend the most time contemplating. 

There are some very important innovations taking place across a number of industries, from medical devices to semiconductors, to biotech-pharma to data analytics–including artificial intelligence and machine learning. 

We see potential for explosive growth in the following fields: digital printing on fabrics disrupting the $1 trillion clothing and garment industry; smart glasses, which in 10 years or less could make holding a smartphone to your face and ears to see the screen or make a call will seem hopelessly quaint and old-fashioned; aesthetics with plastic surgery-like results achieved using much less invasive technologies and techniques; and digital power management necessary for every electronic device, including at the microchip level, as well as many other industries and in many other industries. 

Researching and understanding these changes should be at the heart of any long-term investment strategy.

Bristol: Digital transformation, health care innovation and sustainable investing could offer long-term opportunities, and were even accelerated by the pandemic. These “megatrends” look poised to gain even greater traction as the cycle unfolds.

The pandemic has already hastened our move from the physical to the virtual world – tech and data or AI companies with significant scale-up potential can deliver double-digit earnings growth. Enabling-technologies such as 5G are paving the way for future, yet-to-be-launched “killer apps,” including remote surgery, augmented reality and autonomous driving.

The confluence of health care data and AI is accelerating the speed of innovation in health care, gene-based technologies and new treatments. More focus is already on innovating to provide treatments and vaccines against viruses such as COVID-19.

The crisis also may be the making of ESG investing, as there is growing evidence that ESG-focused funds outperformed during the COVID-19 bear market. 

5) Year-end S&P and 10-year Treasury predictions? 

Bristol: We acknowledge that case growth has slowed and the policy response to the year’s events has been significant, but doubt that S&P 500 earnings per share will hit a new all-time high next year. We see U.S. 10-year Treasury yield moving towards 1.25 percent by the third quarter 2021.  

Frigon: We have no interest in or talent for making such short-term predictions, and to us the end of a calendar year is just another day on the calendar. More important is where your account values will be in 20 or 30 years. 

Lowenstein: Our year-end target for the S&P 500 and 10-year U.S. Treasury are 3,200 and .90 percent. We expect a modest pullback in markets, as they have gotten ahead of themselves, and believe rates will drift higher on higher inflation expectations.

We need to see rapidly improving fundamentals to validate the move we have seen in markets. In recent weeks, economic data seems to be improving, but also decelerating in force.  There is clearly a healing process underway, building confidence and eliminating tail risk of the recovery, but there are still long-term issues we need to resolve and the ultimate recovery shape remains unclear. We seem to be witnessing more of a K-shaped recovery at the moment, reflecting the unique cross currents in effect from COVID. This K-shaped recovery reflects a bifurcated society that has developed whereby the white collar, professional class continues to thrive, while hourly, service-orientated and other blue collar workers continuing to struggle. These two different realities are entrenching, and investors need to pay attention as they could breed future instability in markets. The new economic cycle will look different from the past, but may still rhyme. 

Madlem: When considering the S&P 500 trailing 12-month price-to-earnings ratio, a traditional gauge of U.S. equity valuations we find that stock valuations are significantly higher than a year ago. This includes the devastating second quarter 2020 earnings that were down 20.1 percent from the prior year and at the lowest level in nine years.

With the Fed highly unlikely to raise rates for at least the next 18 months, we discover that the market is undervalued and should head higher in the next months and quarters.