In addition to the difficulty in rehiring these workers, a rolling-wave pandemic and economic uncertainty will likely keep home and auto sales suppressed, as should be evidenced by June auto sales, due out on Wednesday. Economic weakness could be further exacerbated by more layoffs in the energy sector, due to low global oil prices, and declines in state and local government employment, reflecting the inevitable impacts of lower revenues and inadequate federal support.
On the subject of jobs, it should also be noted that classification errors appear to be artificially suppressing the measured unemployment rate. The impact of these errors should fade even as employment slowly rises, leaving the unemployment rate in double digits well into 2021.
This would, in turn, likely force Congress and the Administration to pass further Coronavirus relief bills both this summer and at the end of the year, potentially adding at least a further $2 trillion to the federal deficit. In addition, a slower economic recovery, accompanied by continued low inflation, would like encourage the Federal Reserve to continue quantitative easing until later in 2021 and quite possibly postpone a first rate hike until 2022.
We now expect real GDP to fall by roughly 35% annualized in the second quarter followed by a 20% bounce in the third. Thereafter, while positive policy actions, combined with a rebound in global growth, should prove sufficient to avoid a further outright decline in real GDP, a rolling- wave pandemic should impede further GDP gains, with real economic activity only surpassing its fourth quarter 2019 level by the fourth quarter of 2021. In this environment, corporate earnings would also fall short of analyst predictions, with S&P500 operating earnings per share only hitting a new high in 2022.
So, what does all of this mean for investors?
First, in the short run, some caution is warranted. While U.S. equities still look attractive relative to Treasuries for the long run, there is a significant risk of disappointment in either the medical data or the economic numbers. This suggests the need to hedge equity exposure using either high-quality, long-duration bonds or, better still, more explicit hedging techniques.
Second, the Fed has bought almost 60% of the extraordinary $3.2 trillion increase in federal debt in the last six months and its announcements pertaining to lending facilities have reduced credit spreads on corporate and municipal bonds to levels which hardly seem appropriate in a deep recession. This leaves bond investors both starved of income today and exposed to losses in the long run, assuming that the economy eventually improves enough to warrant a tighter monetary stance. This, in turn, suggests that investors looking for income should search more broadly and, in particular, consider dividend income from equities in sectors that appear less vulnerable to a long pandemic.
Finally, it is important to acknowledge that many countries in Europe and particularly in East Asia have been more successful than the U.S. in taming the virus and should consequently experience shallower recessions and quicker rebounds. This should boost overseas profits relative to those in the U.S. and could also precipitate a dollar decline, given the possibility of more monetary tightening overseas. This, along with the significant valuation advantage outside the U.S., argues for an overweight to international stocks in general, and emerging markets in particular.
There is no point in downplaying the negative impacts of the virus on our emotional and financial wellbeing. In the short run, we will adapt to Covid-19. In the long run we will prevail over it. However, in the meantime, it remains important to see the pandemic for what it is, and position assets not just for the hope of an early cure but the more likely path of a long struggle with a rolling-wave pandemic.
David Kelly is chief global strategist at JPMorgan Funds.