2020 has been a year of records. The longest economic expansion ended with the biggest drop in economic activity and the highest level of unemployment since the Depression. As we know, this all started with the rapid spread of COVID-19, becoming a global pandemic--the worst since the Spanish Flu in 1918. To slow the spread of the virus, social distancing and wearing masks has helped, but at great economic cost. Many consumer and service businesses were shut down and it will be difficult for many to resume their operations.
The damage to the economy has been staggering. In a matter of only a few months, unemployment claims rose to 25 million and the unemployment rate increased from 3.5% to almost 15%. Air traffic came to a virtual standstill. Consumer spending fell almost 13% in April with spending on everything except basic needs halted as we were confined to our homes.
In response, massive monetary and fiscal policy measures were put in place in the U.S. and globally to try to get us through the downturn. The U.S. economy has now begun to recover and credit market conditions have improved greatly, as the Fed continues to provide the necessary liquidity. Housing and capital spending will be key components of the sustainability of the economic recovery and are showing signs of improvement.
The collapse in the stock market as businesses were shut down all happened very quickly. The equity markets in turn have recovered much faster than many expected. After a decline of 20% in the first quarter of 2020 the S&P 500 rose 20% in the second quarter. We are beginning to see evidence that growth in the U.S. is coming back, with consumer confidence rising above its April low, initial claims for unemployment insurance are declining (although still very high), and the global economy is showing signs of improvement led by China.
The problem investors have is that the uncertainties we face are almost overwhelming. Until we get a vaccine or more effective treatment for this virus, it’s almost impossible to know what the next year will bring. In turn, many companies stopped offering any guidance about the future course of their business. We expect many small businesses will not survive the recent shutdown, and others may struggle for some time to get back to where they were. Despite the current conditions, the market seems to be optimistically looking past these problems and some stocks are now selling at very high valuations.
The major U.S. banks are much better capitalized today than they were in 2007 and should be able to handle the bankruptcies and loan losses that will come. Almost every economic measure we follow collapsed in April and May, but then began to rebound in June. The Manufacturing PMI was up 10ppts in the June report, durable goods orders rose 16% vs. last month, new house sales were up 17% m/m, and consumer spending was up 8%. If we are not successful in reopening the economy soon, however, stress on the financial system will escalate.
There are many other unknowns to be considered. At the top of the list would be the upcoming elections in the U.S. and, longer-term, how the world might change after the pandemic. For now COVID-19 remains the most important news story for the market. The surge we see in the number of cases is discouraging, as is the need of 12 states to pause on letting businesses come back. Even so, the 38 states where companies are re-opening are giving a boost to the rebound in the economy.
We acknowledge that we have no idea what the movement in the markets will be over the course of the year. The reality is that the future is always uncertain; we just feel more or less confident at different times. I think you can make a case for various scenarios, and we know from our past experience the best future returns often come when we feel the least confident about the future. We have seen how quickly the mood of the market can change, so rather than trying to time the market, we would rather be long-term investors in a portfolio of securities that have the appropriate level of risk and offer a return potential that meet our needs. For most investors today, equity investments remain the best solution.
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