From an email sent April 30, 2020:
Good evening, IIM investors.
This week’s GDP report formally confirmed what you probably already knew: the economy is either already in recession, or soon will be. That report was unique not only because it was rooted in a global pandemic, but because quarterly economic data won’t really tell us anything we don’t already know. We don’t need to wait until July to know that the second quarter GDP number will be Ugly with a capital u – or that next week’s April jobs report will be a particularly brutal one. What matters for long-term investors now, though, is what happens going forward. And that there is light at the end of the tunnel.
The common definition of a recession is two consecutive quarters of negative GDP growth, although technically, the official dates are determined by the National Bureau of Economic Research (NBER) using a range of data, after the fact. This week’s GDP report showed that the economy shrank by -4.8% in the first quarter – when the economy was just beginning to shut down for COVID…the worst decline since the 2008 financial crisis. For some perspective about how abrupt this is, know that the first negative GDP quarter in 2008 was -2.3%, with five negative quarters in 2008 and 2009 overall, ranging from -0.6% to -8.2%. And that during the bursting of the tech bubble, the economy only shrank two non-consecutive quarters at -1.1% and -1.3% each.
What’s more, the consensus estimate for GDP in the second quarter is -26%…which would easily be the worst in modern history. Initial jobless claims have now surpassed 30 million since mid-March, compared to the 23 million jobs created since the global financial crisis. A whole host of other data, from manufacturing output to retail spending, have plummeted. Other regions around the world are experiencing similar problems, with the Euro-area economy shrinking 3.8% in the first quarter.
Which is why the Fed is “using its full range of tools,” and D.C. has passed a variety of huge stimulus measures – alongside central banks and governments around the world.
The fact that we know why this is happening, and that it will eventually pass, doesn’t make it any emotionally or psychologically easier to navigate, though.
There are a few facts worth remembering as plans to reopen the economy are being put together.
First, the economy was fundamentally strong going into the crisis. This is not 2008, when the financial system ground to a halt due to its own excesses, or 2000, either, when valuations were exorbitant. This time around, the economy was still fundamentally healthy.
Second, COVID-19 cases in the U.S. appear to be plateauing, there are initial signs of possible treatments, and other countries have been able to open up. This suggests that, depending on how we navigate the public health considerations, the U.S. economy can begin to strengthen over the next couple of months. The fact that many of those counted as unemployed are either furloughed or can be quickly recalled back to work is also a positive. Of course, timing matters…being recalled to work in mid-May is very different from July…and not all sectors will rebound quickly, or easily.
Third, although many investors understandably want to see the stars align prior to even thinking about investing again, markets don’t wait for conditions to be perfect. The S&P 500 returned 13% in April and is up 32% since the March low. While we shouldn’t overstate the importance of a single month – and investors should continue to expect a high degree of uncertainty – the point is that markets are forward-looking…even when investors are not.
So, while it’s challenging to do in the middle of a crisis, it is important to focus on longer time horizons. Recessions and bear markets are a natural and unavoidable part of investing. In many cases, they allow the economy to shake off excesses and re-allocate resources, paving the way for future growth. And once a crisis subsides, the subsequent economic expansions and bull markets can last significantly longer.
Below are three charts that help to put recent economic data in perspective.
The economy shrank by 4.8% in the first quarter of the year, the worst drop since the 2008 financial crisis – and the early 1980’s before that. The economic shutdown that drove this number didn’t truly take effect until the second half of March. Thus, it’s widely expected that the Q2 numbers will be much worse.
Since this is already well understood and expected, though, it’s important for investors to look ahead. If businesses can responsibly reopen in the coming months, then economic growth will begin to recover.
The business cycle was in its 11th year before the coronavirus crisis, having begun in mid-2009. Not only was this last economic expansion the longest in history, but it grew at a steady pace. The fact that the economy was healthy entering the crisis increases the likelihood of a recovery.
Long-term investors will inevitably face many ups and downs over the course of their lives. It’s important to keep this in perspective and focus on what truly matters:
While most investors would of course prefer for conditions to be perfect…the reality is that they don’t need to be in order to realize healthy returns.
Please let me know if you have any questions.
Thank you and stay safe.
Islamorada Investment Management