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As efforts to stem the spread of COVID-19 continue, uncertainty remains high across global financial markets. The pandemic-driven selloff, heightened by turmoil in global oil markets, is unprecedented in its speed and severity. Volatility and correlations across asset classes are reminiscent of the global financial crisis, as investors seek to reduce risk exposure as new information is released daily. The purposeful halting of the global economy is jarring in the short term and raises questions about the pace and timing of the eventual recovery.
Our view of the economic impact in the United States reflects a significant decline in both employment and gross domestic product (GDP) growth over the coming weeks and months. These metrics are likely to remain weak into the third quarter but could start to show some improvement as we enter the fourth quarter of 2020. While it’s clear that the United States will presumably fall into recession (defined as two quarters of negative GDP growth), we see this sharp and severe downturn as temporary.
We have confidence that the unprecedented global coordinated response by scientists, technologists and engineers, working in parallel on a vaccine and therapeutic treatment, will lead us past this crisis. The US economy has tremendous depth and strength; though the crisis will test many areas of the country, we don’t believe it will lead to a global depression or multi-year downturn.
Looking forward, we are closely watching multiple factors as we think about the path to recovery.
- First, when we look at the countries in Asia where the virus had the earliest impact, new cases have slowed in China and South Korea, people are returning to work and consumers are starting to resume traditional spending patterns. Franklin Templeton’s research teams in Asia have been providing on-the-ground perspectives and insights as the situation evolves in the region. We view this as a good leading indicator that suppression strategies taken in the United States and Europe can be effective at “flattening the curve.”
- Second, the Federal Reserve acted quickly to inject substantial liquidity into the market. This was followed by a US$2 trillion stimulus package designed to support the economy across myriad segments, corporate and individual. These measures align with broader policies and programmes that governments worldwide are implementing in an effort to stabilise the global economy. While it will take time to see these actions have an impact, we believe they can be very effective.
- Lastly, at the core of these economic challenges is a global health crisis. The pace and extent of our recovery will be very linked to scientific progress on cures, vaccines and/or treatments. These discoveries will have tremendous impact not just on how severe the downturn will be, but also how our lives may be impacted in the years ahead.
The Consumer Concern
Our biggest concern, and one we are monitoring closely, is how the COVID-19 disruptions will impact US consumer behaviour. The US consumer has been the driving force behind the economic expansion of the last decade, benefitting from low inflation, strong employment and rising wages. Presently, containment measures (e.g. business closures, travel restrictions and stay-at-home orders) are in effect in many localities in the United States to slow the spread of the virus.
The impact of the shutdowns on employment and the consumer will be severe; unemployment claims could reach record levels in the coming month. Areas like travel, hospitality and traditional retail were naturally the first to bear the brunt of the shutdowns, but the overall effects will likely be more widespread. Once these disruptions moderate, we will be actively evaluating the pace at which the return to normal daily life resumes.
Many of these concerns and headwinds have likely been discounted into current equity valuations, though uncertainty about the timing of earnings recovery means it is still too early, in our view, to say the market is broadly cheap or that we have seen the bottom in equity prices. US equity markets moved swiftly and severely over the past several weeks; while correlations across sectors have increased, when you investigate the details it is clear that the market is discriminating based on fundamentals, whether they be high leverage, interest rate sensitivity, oil price exposure or significant revenue disruption, to name a few.
At the same time, the impact of the “stay-at-home” response to the pandemic may be accelerating the adoption of the broader digital transformation themes we’ve identified. It’s influenced how we socialise, do our work, and procure goods and services, and we anticipate these behavioral shifts will have a lasting effect for many consumers.
During this volatility, we’ve seen opportunities to initiate or add to positions in what we consider to be high-quality, long-term growth companies that are well-positioned for the future. As always, we seek those that we believe are best-in-class companies levered to multi-year growth trends and disruptive innovation themes. Technology and health care have been two areas that we believe will continue to see ongoing secular growth; within the consumer space, we believe opportunities exist in highly regarded, competitively positioned companies. In our view, these types of investments can weather the current volatility and generate solid risk-adjusted investment performance over a long-term horizon.
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