Vanguard Market perspectives: May 2020

Vanguard Market perspectives: May 2020

April 28, 2020

Key highlights

  • The global recession will be short, with growth turning positive in the second half.
  • Developed economies will not return to normal until later in 2021.
  • Labor markets in face-to-face sectors such as leisure and hospitality will be hit hardest.
  • Expect the U.S. to lift shelter-in-place measures and most extreme social distancing by June 30.
Asset-class return outlooks

Recent market performance has moderately raised portfolio expected returns. Our preliminary 10-year annualized nominal return projections, as of March 31, 2020:

U.S. equities                                            4.8%–7.8%
Global equities ex-U.S. (unhedged)        8.3%–11.3%

Fixed income
U.S. bonds                                              1.0%–2.0%
U.S. Treasury bonds                               0.4%–1.4%
Global bonds ex-U.S. (hedged)              0.4%–1.6%
U.S. cash                                                0.4%–1.6%

These probabilistic return assumptions depend on current market conditions and, as such, may change over time. IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of September 30, 2019. Results from the model may vary with each use and over time. For more information, please read the notes section.

Countries battling the pandemic look ahead

Several countries recently among the world's hardest hit by the COVID-19 pandemic are beginning to talk about how and when they might start to reopen their economies.

  • Renewed containment efforts in countries including Japan and Singapore, which had experienced early success in containing the coronavirus through vigorous testing and tracking, remind us that the battle isn’t easily won, and may not be over until a vaccine is developed or broad populations achieve immunity.

  • The strength of the eventual recovery will depend in large part on the duration of required containment measures, the depth and breadth of unemployment, and the extent to which consumers overcome lingering fear of resuming normal activities.

  • It will be crucial to avert a second wave of infection.

Expect the sharpest global recession in recent history

Growth in the United States and Europe is expected to contract in the second quarter at the steepest pace since at least the 1930s.

  • We continue to anticipate that the global recession will be short, however, with global growth turning positive in the second half of 2020.

  • We expect the recovery will be "U-shaped" in that it will be at least the end of 2021 before economic activity returns to its pre-COVID-19 level.

  • We expect recovery to proceed in two stages, as we're beginning to see in China: a bounce-back in growth as supply constraints recede, but a longer wait for demand to strengthen.

Global scenario estimates and transmission channel impact

 In Vanguard's best case, our 2020 growth estimate for the world is -2%.

China and developed economies are on different paths

Although we see China's economy returning to normal by the end of the year (assuming no significant second wave of infection), we believe it will take three or four additional quarters before developed markets' economies return to normal, likely toward the end of 2021.

Will stimulus measures be sufficient? The key question remains if they will be enough to bind employees to their jobs and keep solvency measures for households and businesses high.

When will the global economy reopen? We expect a gradual and rolling reopening of global supply commencing in the May timeframe as regions move beyond peak infections.

How important is a health care solution? The speed and shape of a demand rebound is critically tied to the degree of confidence in future health care solutions.

United States. Vanguard believes that GDP in the United States could contract at a significantly greater degree in the second quarter than it did at the worst point of the global financial crisis, with the extent and timing of recovery dependent on when containment efforts can be rolled back.

  • In our current base case scenario, the U.S. lifts shelter-in-place measures and most extreme social distancing by June 30.

  • The U.S. Federal Reserve has taken steps to support the flow of credit to the economy, making loans available to assist households and employers of all sizes, and bolster the ability of state and local governments to deliver critical services during the coronavirus pandemic.

  • We believe that the unprecedented response by the Federal Reserve and Congress will help stave off worse outcomes.

  • Small businesses with little ability to work from home represent over 50% of industry employment, so fiscal policy providing small-business loans and expanded unemployment insurance is essential.

  • If there is mass unemployment coming out of the downturn, growth impacts are likely to persist for longer.

  • Valuations remain below fair value estimates for U.S. equities, and the long-term picture has brightened for them.

China. Although the worst of the coronavirus-related economic effects may now be in China's past, we expect normalization to be slow.

  • China's GDP declined by 6.8% in the first quarter of 2020 compared with the fourth quarter of 2019, the first such economic contraction since China began reporting quarterly GDP figures in 1992.

  • We expect that weak global demand and slower-than-expected normalization in domestic service industries will prohibit a strong bounce-back in growth in the second and third quarters.

  • China's first-quarter GDP numbers also shouldn’t be viewed as a harbinger for second-quarter GDP data in other countries, given vast differences in economic structures and epidemiology.

Euro area. Evidence that the virus outbreak has peaked in Italy, Spain, and Germany is leading to expectations that lockdowns within the euro area will begin to gradually be lifted this month.

  • Vanguard's view that the economy can start to rebound in the third and fourth quarters as lockdowns are removed is tempered by the risk of a second wave of infection that could necessitate containment measures to be reinstated.

Full report can be found here.