March 22, 2020 | Expert Perspective
In only a few months, COVID-19 has spread around the world. The extreme measures being taken to protect us, to combat the disease’s spread, should be positive for public health. But such a step necessarily involves a trade-off. In appropriately prioritizing human health, we in essence must shut down large swaths of the economy, closing schools and businesses and limiting human interaction.
Having to do so makes it unfortunately clear that a global recession is at hand.
Given increased efforts to contain the spread of the coronavirus, we anticipate a sharp (but we hope short) contraction in the U.S. economy, which likely has already entered into recession this month. The coming months are likely to witness a profound fall-off in the real economy.
For some time, we have been estimating the likely impacts of the virus' spread through a number of channels, including reduced trade, restrictions in supply chains, tighter financial conditions, and, perhaps most significantly, social distancing measures. This latter effect is leading to a profound decline in consumer spending in the "face-to-face" sectors of the economy, namely hotels, restaurants, air travel, and related activities. We expect consumer spending in the months ahead to decline at the sharpest pace since at least World War II, with clear impacts to employment.
As shown in the illustration, real GDP is likely to contract in the coming quarter by nearly 17% on an annualized basis. This would mark the deepest quarterly decline since at least the 1950s. This will be a trying time for all of us, and certainly for the U.S. economy.
We expect, however, that this could also turn out to be among the shortest recessions in our history. Importantly, we assume that the need to significantly restrain activity, such as the closure of non-essential businesses, will dissipate by late in the second quarter. Under such a scenario, and with aggressive fiscal and monetary policy measures, we would foresee a rebound in growth in the third quarter to mark the end of this sharp yet short recession.
Financial markets have sold off significantly over the last several weeks, with eye-watering volatility. While we noted in our annual economic and market outlook that there was an elevated risk of a correction in the stock market, the speed of this bear market has certainly taken me by surprise.
A positive side, however, is that the long-term picture has brightened for equities. As the illustration shows, the recent sharp downturn has brought returns more in line with the previous outlooks provided by our Vanguard Capital Markets Model®. As you can see, over longer periods we've had a fairly good record of anticipating where future stock returns would be, on average, over the next ten years. Our forecasting accuracy results from our framework that is based, in part, on stock-market valuations. Until the pandemic, valuations were elevated, explaining why we expected muted stock returns.
A ray of light is that, looking over the next ten years, our stock market outlook is starting to improve. The reason? The role that current valuations, which have contracted in the recent sell-off, play in our long-term forecast. Put simply, the price of most equities has become much lower than it had been, giving equities more room to grow before they reach what we'd consider to be their fair value. The theme broadly holds true for ex-U.S. equities. A similar dynamic also occurred in 2009, when the global economy was in a deep recession and stock prices were low.
In this 4 minute video, Vanguard Global Chief Economist Joe Davis shares his outlook for global growth during the coronavirus pandemic.
Greg Davis: Well, it’s great to have you with us today, Joe. And for our clients, Joe is our global chief economist and you’re seeing just a complete look at the world in terms of what the coronavirus is doing from an economic impact. We’ve seen states, cities being shut down virtually from an economic activity standpoint. I’d love to get your perspective of the impact that’s going to have on economic growth and what that means.
Joe Davis: Thanks, Greg. I mean, it’s profound. I mean, I’ve been watching the global economy for over 20 years and this is one of the biggest shocks to ever hit the global economy. I mean we’ve seen as, you know, and as investors know, the COVID-19 in one sense, positively the efforts to try to control the spread of the virus. But the very act of trying to do so is obviously really leading to shuttering of businesses and a significant now contraction in the global economy. It started in China and now we’re witnessing significant disruptions in both Europe as well as the United States.
The global economy is now entering recession, which means business activities contracting or falling, and we anticipate further declines. They are going to be significant over the coming months—the severity of which really depends on two things. One would be how long the containment measures are necessary, right? Which we don’t exactly know. And then secondly will be the policymakers’ response, which has been positive I’d say to date. And we would expect some more.
But bottom line is, the U.S. economy has entered a recession. It will likely be in our judgment, one of the sharpest declines in our history, at least to records going back to World War II. I would also say one positive, potentially, is that it could also be among the shortest recessions because the nature of the recovery really hinges on our need for further containment measures. The less the need for that, then that would allow businesses to reopen and we would see a resumption of some activity, which would be positive for growth. But you know increasingly the financial markets are anticipating the significant fall, and we do share that forecast, at least over the next several months.
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