What the Market and the Economy May Need Now | Lord Abbett
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Market View

We believe the path to full economic and market recovery in the U.S. will depend on three (and a half) transitions.

Read time: 4 minutes

As of mid-June, the stock market had rebounded off the bottom reached in March, suggesting that economic recovery was not far behind. But stocks have moved sideways since then, indicating that investors believe the economy is not yet in the clear. We think support for a full recovery in the economy and asset prices will not occur until economic, monetary, and fiscal transitions are completed. The November election could also be significant.   

The Economy: From Partially Open to Fully Open and Growing

Although the economy has largely moved from widespread shutdowns to partial re-openings, we think it now must move from partial re-openings to a state of steady improvement even as the pandemic continues. At the height of the shutdowns, the personal savings rate soared as consumers cut back on spending, particularly in the areas of entertainment and travel. Small businesses also slashed their capital spending plans in light of reduced demand.

For the economy to reach full recovery, we think personal consumption will have to improve, and small business capital spending will have to rebound. For this to happen, the scientific and public health uncertainties surrounding the nature and spread of the virus will have to be resolved. And it’s possible this may not happen until a vaccine or therapeutic treatment is developed.

 

Figure 1. Personal Savings Soared while Small Business Capex Plummeted

Households and businesses must return to spending despite the risks

Source: Personal Savings Rate: Bloomberg and Lord Abbett data as of May 31, 2020. Small Business Capital Spending Plans: Bloomberg and Lord Abbett data as of May 31, 2020; “3MMA” refers to 3 Month Moving Average, Higher-Lower versus Small Business Survey; Bloomberg data and Lord Abbett analysis.

 

Monetary Policy:  From Sustaining Markets to Stimulating Growth

We think the response of the Federal Reserve to the COVID-19 pandemic was rapid and robust. It enabled markets to keep functioning, assisted investors in moving into safe assets, and gave corporations access to credit in the commercial paper and bond markets. State and local governments were also supported with a lending facility.

In our view, Fed policy now needs to move from providing emergency support to stimulating economic growth. This, however, will be difficult. Normally, the Fed would cut the federal funds rate, but this is already near zero. So, with the Fed somewhat constrained, alternative policies may become necessary.   

These could include forward guidance on future rates based on targets for unemployment rates and inflation, and a commitment to ongoing balance sheet expansion. Targeted lending programs could also stimulate growth, authorized under the same provision of the Federal Reserve Act that allowed other emergency lending programs.

Finally, the Fed could also engage in yield curve control, a policy that has been used by the Bank of Japan over the past several years. The aim would be to pin rates at longer maturities along the Treasury yield curve, perhaps as far out as three years or more, near zero, thus reducing borrowing costs in credit markets as well.

Fiscal Policy:  From a Temporary Bridge to Support for a Permanent Reopening

Emergency fiscal spending programs, including the COVID-19 Aid, Relief, and Economic Security (CARES) Act, supported consumers and businesses in the wake of widespread shutdowns. These programs helped keep consumer spending, which makes up nearly 70% of GDP, from experiencing a larger decline.

But these programs are now coming to an end. Much of the family assistance aid has been spent, the Payroll Protection Program loans have been made, and the enhanced unemployment program is set to expire at the end of July.

Congress will pass a new stimulus package in order to prevent a deep, extended recession. But this may be more difficult than passing the initial relief because it has produced record deficits and total debt. So, the size of the next fiscal stimulus package may be constrained.  

In fact, some adjustments to the initial relief would be beneficial. For example, the $1,200 family assistance payments were made regardless of employment status, and recipients with relatively high incomes saved their payments or used them to pay down debt. Thus, these payments produced little stimulus effect.

Similarly, one option being considered for the next round is a payroll tax cut. But this would not be effective because it would affect only people who still have their jobs and only companies that still have their payrolls.

In addition, financial support of state and local governments, whose tax revenues have collapsed, should be included in the next round. Otherwise, we think layoffs of teachers and public safety employees are likely.

 

Figure 2. Additional Fiscal Support Will Be Needed

Programs have provided some support to the economy as consumption has plummeted

Source: Brookings Institution, Hutchins Center on Fiscal and Monetary Policy. Projections displayed through December 31, 2021.

 

A Half Transition:  The November Election

We think the election could result in a transition that takes the form of a change in leadership, not only at the presidential level but also in Congress. Alternatively, it could merely ratify the status quo. A change in leadership would mean a new direction for tax policy, regulatory policy, and a host of other areas.

These changes seem likely to affect the economy, in our opinion, but history provides little guidance about the election’s likely effect on markets. Generally, stocks tend to perform better after a presidential election because it removes the political uncertainty that had weighed on returns. This holds whether the outcome is a divided government, a change from one party to another, or an undivided government.  

But the effect of the winning party and the extent of the win are inconsistent. When an election results in a continuation of divided government, returns in the first three months exceed those that occur when one party takes control. But 12 months after the election, this effect largely disappears. Ultimately, although presidential elections have an effect on markets, other factors also come increasingly into play over time, confounding the political effect.

Summing Up

Clarity on these three and a half transitions is necessary before investors can surmise how this recovery will play out. New forms of support from the Fed will be necessary, as conventional monetary policy is constrained by record-low interest rates. Fiscal stimulus will also be necessary, but this is also constrained by record-high budget deficits and debt. As for the election, it could produce a change in policy direction, but predicting its effect on the market is difficult, and any effect is unlikely to be long-lasting. Ultimately, the path to economic recovery may not be clear until a COVID-19 vaccine or therapeutic treatment becomes available.

 

IMPORTANT INFORMATION

A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.

No investing strategy can overcome all market volatility or guarantee future results. 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Any mention of the "Fed" in this in this material refers to the U.S. Federal Reserve. Market related discussions are generally based on the U.S. markets and related U.S. policies except where otherwise noted.

Yield Curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

Yield Curve Control refers to a central bank’s (such as the U.S. Fed’s) effort to target a longer-term interest rate by buying/selling as many bonds as necessary to hit its rate target.

This article may contain assumptions that are “forward looking statements, ” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Copyright © 2020 of Lord, Abbett & Co. LLC. All Rights Reserved. This material may not be reproduced in whole or in part in any form without the permission of Lord Abbett.

Note to European Investors: This communication is issued in the United Kingdom and distributed throughout Europe by Lord Abbett UK Ltd., a Private Limited Company registered in England and Wales under company number 10804287 with its registered office at Tallis House, 2 Tallis Street, Temple, London, United Kingdom, EC4Y 0AB. Lord Abbett UK Ltd (FRN 783356) is an Appointed Representative of Duff & Phelps Securities Ltd. (FRN 466588) which is authorised and regulated by the Financial Conduct Authority.

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