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At the end of 2019, we foresaw market volatility and a vulnerable, late-cycle global economy. But we did not anticipate the most serious pandemic in a century. Its impact on the market was jarringly fast:
February 19, 2020: The S&P 500 Index closes at a record high of 3,386.15
March 12, 2020: S&P 500 Index bear market begins with 20% decline from peak
Time from peak to bear market: 16 trading sessions
April 20, 2020
West Texas Intermediate (WTI) futures prices for delivery in May fell to -$37.63/barrel—
the first-ever negative WTI oil price
March 9, 2020
U.S. Treasury 10-year rates fell to a record in-session low of 0.318%
In this report, we explore the ramifications of this extreme volatility, what it means for the markets, and what investors need to consider in the months and years ahead.
Read more from Darrell L. Cronk, CFA, president of Wells Fargo Investment Institute.
Paul Christopher, CFA, Wells Fargo Investment Institute Head of Global Market Strategy, looks at what expectations are for a recovery out of this recession, potential opportunities as the bear market evolves, and how investors may want to position for the potential of additional volatility in the second half of the year.
The pandemic will affect the path and speed of the recovery in the months ahead, but we believe that five main themes are already changing how investable markets interact with the economy.
Click the numbers below to learn more.
The global financial crisis of 2008–2009 led to higher savings rates among consumers. Today, wide-scale unemployment may reinforce that lesson, leading to further increases in savings—which may also impair future consumption.
After a multi-decade decline, the U.S. personal savings rate has shown a significant increase in recent years as consumers respond to economic shocks.
This page includes a chart graphic; a text alternative is available at the link below.Since January 1960, U.S. personal savings rates have ranged from a high of 17.3% in May 1975 to a low of 2% in July 2005. It spiked to 33% in April 2020.
Businesses can increase flexibility by adding technology that uses less office space, reduces travel, and automates customer service, marketing, and supply chain processes. We expect more—not fewer—jobs but employers will demand new skills and flexibility.
Companies would like more flexible and shorter supply chains but will weigh the cost of maintaining dispersed operations. At the same time, increasing supply chain flexibility does not imply reshoring all or even most supply chains. We believe that the pandemic and the preceding trade dispute will focus management on balancing flexibility, efficiency, and risks across their businesses.
There is growing political rhetoric to return production of strategically important goods to the U.S.
This page includes a chart graphic; a text alternative is available at the link below.Source by country or region of active pharmaceutical ingredients in U.S. prescription drugs as of August 2019: U.S. 28%, European Union 26%, India 18%, China 13%, Canada 2%, rest of the world 13%.
The costs of virus containment will strain national budgets, which already have less room for support than the U.S. (think Brazil, Mexico, and India). And in Europe, political disagreements about government finance are likely to intensify, potentially straining relationships and blocking policies that could enhance growth.
However, if the pandemic strains emerging market public budgets and aggravates deflation in Europe and Japan, the U.S. dollar eventually could break above the cap that we foresee for the next 18 months.
Foreign investment has historically left emerging markets during economic disruptions—which can accentuate the effect of the crisis on those economies.
This page includes a chart graphic; a text alternative is available at the link below.Foreign investment in emerging markets dropped in the first 80 days of the COVID-19 pandemic by nearly four tenths of a percent of gross domestic product of a sample of emerging market countries which was greater than the drop in investment during the global financial crisis of 2008 (down .25%), the taper tantrum of 2013 (down .14%), China’s currency devaluation of 2015 (down .04%), and the emerging market sell-off of 2018 (down .07%).
Sources: International Monetary Fund and Wells Fargo Investment Institute, March 31, 2020.Countries included in the sample include China, Brazil, Hungary, India, Indonesia, Korea, Mexico, Pakistan, Philippines, Qatar, Sri Lanka, South Africa, Taiwan, Thailand, Ukraine, and Vietnam. Lines show daily outflows for the first 80 calendar days of each crisis (Jan. 13, 2020 for COVID-19).
The Taper tantrum was the May 2013 collective reactionary panic that triggered a spike in U.S. Treasury yields, after investors learned that the Fed was slowly putting the brakes on its quantitative easing (QE) program.
Greater government involvement in the economy poses several risks to financial markets:
We expect health care to become a much larger investment focus. Important growth drivers will include building stockpiles of supplies, increasing hospital capacity, and adding staffing and funding for governmental agencies that ensure health care preparedness.
In the future, we believe the health care system will expand even faster to build flexibility for aging populations and possible future epidemics.
The U.S. healthcare system was about 17% of gross domestic product in 2018—and was nearly double the 9% share among the world’s most developed economies.
This page includes a chart graphic; a text alternative is available at the link below.The U.S. health care system was about 17% of the U.S. economy in 2018, which was nearly double the 9% average share among the world’s most developed economies including Spain, the United Kingdom, Norway, Canada, Japan, France, Germany and Switzerland.
The trajectories of these themes will depend heavily on how events and the risks cited above evolve in the years ahead, but we strongly suspect that—through 2021 and beyond—resilience will figure prominently in the temperament of successful investors.
These themes align with the tactical recommendations you’ll find below.
| 2020 | 2021 | |
|---|---|---|
| U.S. GDP Growth | -4.5% | 3.0% |
| U.S. inflation Consumer Price Index | 0.7% | 1.7% |
| S&P 500 Index | 3,150–3,350 | 3,400-3,600 |
| Federal funds rate | 0.00% – 0.25% | 0.00% – 0.25% |
| 10-year U.S. Treasury note yield | 0.75% – 1.25% | 1.00% – 1.50% |
| West Texas Intermediate crude oil per barrel | $35 – $45 | $40 – $50 |
Examining the contours of change, and how we believe investors should adapt.
After a strong late-year start in 2020, we believe the economic recovery should mark a moderate 2021 pace.
We believe a moderate economic recovery is the most likely outcome.
We expect a return to positive international growth in the second half of 2020.
We expect low, but positive, U.S. inflation. Deflation (falling prices) is likely in other developed economies.
We expect the dollar to slip further from midyear 2020 levels. However, U.S. leadership in the global economic recovery should moderate the dollar’s dip and remains the basis for a tilt toward U.S. assets.
A slow recovery through 2021 would continue to favor higher-quality, more liquid assets.
We expect the U.S. to avoid deflation but to see inflation slow to less than half of the Federal Reserve’s (Fed’s) official 2% target rate similar to the last cycle’s declines in spending and oil prices.
In the last economic cycle from December 2006 to December 2011, 19 months after its peak, prices as measured by the Consumer Price Index fell 2% year over year. In this economic cycle starting in February 2019, prices have risen 0.4% year over year.
We’ve reduced our 2020 earnings-per-share targets; here are the key considerations for investors now.
Corporate earnings will be impaired in 2020; we expect profits to rebound in 2021.
Higher-quality U.S. equity classes and sectors should continue to outperform during the recession and while economic and earnings uncertainty persists.
Investors who are not at their target allocations for U.S. large- and mid-cap equities might consider rebalancing from potentially riskier equity classes, especially U.S. small-cap equities and developed and emerging market equities.
Large-cap and mid-cap equities have the lowest exposure to highly cyclical sectors—reinforcing our favored view of these asset classes in a weak economic environment.
26% of holdings in the S&P 500 Index are considered highly cyclical compared to 40% of the Russell Midcap Index, 41% of the Russell 2000 Index, 41% of the MSCI Emerging Markets Index, and 44% of the MSCI EAFE Index.
The liquidity that has been injected into fixed-income markets is historic. What does it mean for fixed-income investors?
The Fed should be slow to reverse easy monetary policies, which should help to support many fixed-income asset classes.
While quality remains important, we believe that investors can begin to add higher-risk holdings to their fixed-income portfolios.
As the economy recovers, fixed-income investors are more likely to be rewarded for taking risk.
We expect the Fed to remain on hold through year-end 2021. With short term rates near zero investors should be cautious with excessive cash balances.
We expect a substantial increase in issuance for Treasury securities and across many fixed-income classes and sectors. We anticipate that this new issuance will be absorbed by market participants and by Fed balance-sheet purchases.
Assets held on the Federal Reserve balance sheet have increased from $4.2 trillion at the beginning of 2020 to $7.1 trillion in May 2020. The total was less than $1 trillion in 2007.
Demand shocks often lead to supply reductions—which can be price-positive as demand recovers. What should investors consider?
Commodity prices look set to rebound; we turned favorable on March 12.
Global Real Estate Investment Trusts’ (REITs) future looks uncertain in a post-pandemic world; we turned unfavorable on April 30.
Global REITs likely will underperform other real assets.
Stay high quality in the midstream space, even as energy prices bounce.
Crude oil and gold should outperform most other real assets.
Midstream prices held up relatively well amid the energy sector sell-off. We favor high-quality assets in the midstream space.
Since December 31, 2019, the midstream energy sector as measured by the Alerian Midstream Energy Index (down 28%) has outperformed other energy sectors such as master limited partnerships (down 31.2%), equipment/services (down 53.7%), drillers (down 72.1%), integrated, refiners (down 31.5%) , and exploration/production (down 38.8%).
Sources: Bloomberg and Wells Fargo Investment Institute. Daily data, December 31, 2019–May 22, 2020. Indexed to 100 as of start date.
Midstream is represented by the Alerian Midstream Energy Index, MLPs by the Alerian MLP Index, Equipment/services by the S&P 1500 Oil & Gas Equipment & Services Index, Drillers by the S&P 1500 Oil & Gas Drilling Index, Integrated by the S&P 1500 Integrated Oil & Gas Index, Refiners by the S&P 1500 Oil & Gas Refining & Marketing Index, and E&P by the S&P 1500 Exploration & Production Index, WTI=West Texas Intermediate.
Performance is measured as the total return of each index. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results; assume the reinvestment of dividends and other distributions; and do not reflect deductions for fees, expenses, or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Please see the end of this report for definitions of indices, and descriptions of asset-class risks.
The oil crash and coronavirus pandemic will present opportunities for alternative investments during different phases of economic recession and expansion. What should investors consider?
Forward returns are compelling in Structured Credit but risks remain.
We are early in a default cycle that could be larger than the 2008 global financial crisis.
Investors should ensure that they are positioned for rising defaults and for eventual economic recovery.
March 2020 was the most recent epitome of fear and dislocation. Based on history, we would expect actual defaults and accompanying restructurings to soon follow.
The distress ratio calculated by dividing the total face value of bonds priced below $75 in the ICE BofAML Developed Markets High Yield Index by the total face value of bonds within the index spiked in March 2020.
The full report, 2020 Midyear Outlook: Recession, Recovery, and Resilience, includes additional insight from Wells Fargo Investment Institute that can help investors make informed decisions through the rest of 2020 and beyond.
The report includes favored sectors and the full economic and investment forecast for 2020 and 2021.
For additional insight and market commentary, visit our website. For assistance with your investment planning or to discuss the points in this report, please talk to your investment professional.
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