Tidal Wave of Policy Support Lifts Markets. Will Economy and Earnings Follow?

QMA’s 3Q 2020 Outlook examines the V-shaped equity market recovery, economic recovery prospects in the second half of the year, and portfolio positioning for continued uncertainty.

July 15, 2020

The COVID-19 pandemic has plunged the economy into a deep recession that ended the longest global expansion in the post-war era, as governments in major economies imposed lockdowns and shelter-in-place orders. While the lockdowns have generally been successful in “flattening the virus curve,” these measures crushed economic activity, leading to a stunningly large decline in global GDP. While global economic activity started off the year on a strong footing, the supply and demand shock stemming from COVID-19 caused sharp declines in GDP beginning in March, which put quarterly annualized GDP numbers for the major economies deep into the red for the first quarter. The second-quarter numbers, which spanned a long period under lockdown, are expected to be truly shocking, especially in the United States and Europe.


Depression-Like Contractions Expected for 2020’s First Half

Source: OECD Economic Outlook as of June 2020.

The visual shows the GDP percentage change in between 4Q 2019 and 2Q 2020 across a range of countries and regions.


QMA expects global GDP growth to recover in the second half of the year, as the apparent success in flattening the virus curve has led to a rollback of the lockdown measures and a reopening of major economies to varying degrees. The global policy response to the pandemic has been truly massive. It’s completely dwarfed the policy response in the aftermath of the global financial crisis and also arrived in a much timelier manner. This has helped stave off total economic collapse, reduced collateral damage, and hopefully provided the necessary support that will sustain the economic recovery. A variety of indicators suggest economic activity bottomed in 2Q and a rebound has begun.


The Liquidity Tsunami

The United States has led the way in delivering a surge of liquidity from monetary and fiscal stimulus. The U.S. Federal Reserve (the Fed) has unleashed an extraordinary array of measures, restarting many of the liquidity facilities from a decade ago but also expanding them to new areas, including municipal and corporate bond markets. The central bank even launched a Main Street lending facility to support credit for small and mid-sized businesses. The collective impact of these measures has resulted in the Fed’s balance sheet growing from $3 trillion in March to $7 trillion in June, and it is on track to continue increasing. As a percentage of GDP, the Fed’s balance sheet has expanded by 15% to date during this crisis, versus 9% during the entirety of the global financial crisis. At the June 2020 meeting, the Fed reassured markets that policy rates would stay at zero through the end of 2022 and large-scale asset purchases would continue as needed.

On the fiscal side, the U.S. government has delivered nearly $3 trillion in fiscal stimulus to support individuals and impacted businesses, and more is likely on the way in a presidential election year. Additional measures expected in July are likely to raise the annual budget deficit to nearly 25% of GDP, a level unseen in recent decades and on par with levels last seen during the Second World War.

While the U.S. government has delivered the most aggressive stimulus program to stave off depression, the rest of the world has also risen to the occasion. The European Central Bank, the Bank of Japan, and the Bank of England have all followed the Fed in ramping up or restarting asset purchases and rolling out various liquidity facilities. In Europe, several countries have launched fiscal stimulus programs individually, and the European Union created a recovery fund that will offer grants to sectors and regions most impacted by the pandemic. This is a game changer for Europe, not only in terms of its ability to jointly tackle the COVID-19 crisis, but also as an important sign of European solidarity and of a willingness to deploy a new type of support from European institutions to assist member states. Meanwhile, emerging market governments are also contributing, with China’s aggressive fiscal and monetary policy leading the way. The overwhelming policy responses and substantially lower rates have driven financial markets higher, despite the plunge in forecasted earnings and elevated price/earnings ratios.

Preparing for the Aftermath

Despite all the stimulus, we’ve dug ourselves into a sizable economic hole, and global economic activity is unlikely to reach pre-pandemic levels for an extended period. Even with the second-half rebound and 2021 recovery embedded in consensus economic forecasts, activity levels are still foreseen to be below pre-pandemic levels 18 months from now. It’s possible that the current economic consensus is too pessimistic and that quicker-than-expected medical breakthroughs might allow the economy to recover the lost ground more quickly than QMA foresees. However, it’s also possible that a variety of risks could act to delay/derail the long climb back to pre-pandemic levels, including a second-wave spike in COVID-19 infections, adverse economic and legislative outcomes stemming from the U.S. presidential election, and rising geopolitical risks.

At the moment, QMA does not think it’s an opportune time to be taking big tactical bets, such as embracing an aggressive pro-growth strategy or a full-on defensive positioning. Markets are facing a dizzying array of cross currents, and, as a result, QMA is sticking closer to policy benchmarks and taking only measured, selective bets. They see fixed income risk assets (including corporate debt) as a better bet than equities given the former’s better valuation relative to history and a more direct link to central bank asset purchases. They maintain an overweight position to cash in their portfolios as dry powder should the market pull back. They believe the U.S. dollar has peaked or at least stabilized. The dollar is expensive on many measures, and narrowing interest rate differentials between the U.S. and other major markets remove a key pillar of support. Improving global growth trends are also a headwind for the dollar, as the dollar is generally a counter-cyclical and safe-haven currency.

Read the full QMA 3Q 2020 Outlook and Review PDF opens in a new window, which is available for financial professionals.


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