The Square Root Recovery
Jerry Chafkin, Chief Investment Officer, AssetMark
- The stock market rebounded sharply in Q2, rising almost as quickly as it fell in Q1, returning 18.2% for the first two months of the second quarter. The market’s sharp drop and recovery is probably a function of the unique nature of the shut-downs, with state governments imposing restrictions that turned off the economy like a light switch and then lifting the restrictions effectively switching it back on again.
- The sharp recovery in the US stock market is unlikely to be mirrored in the recovery of the US economy, which for Q2 is estimated to contract anywhere between 25% and 52% (annualized). The economic recovery will likely be slowed by double-digit unemployment through next year, given that domestic demand contributes two-thirds of the US economy and continued high unemployment will create a drag on consumer spending.
- Today’s historically low interest rates across a broad range of maturities reflect the bond market’s skepticism about the prospects for economic growth.
- The seeming disconnect between the stock market and the economy is partly explained by timing, but there are also longer-lived issues that probably have greater explanatory power, including: fiscal stimulus approved by Congress, behavioral biases regarding how investors weigh the probability of positive vs. negative surprises, the distribution of job losses across different economic groups, the very different paths to recovery likely to be experienced by different industries, and a restructuring of the stock market with the effect that a handful of companies are likely to define stock market returns but will not necessarily drive job growth.
- While market movement within a quarter, or from one quarter to the next, may be interesting to traders, it is less useful to longer-term investors planning for retirement, or for retirement income. Given the challenges and uncertainty facing the economy and the markets in the next few years, well-diversified portfolios with a modest tilt to the stocks and bonds of high-quality companies are recommended.
For the full report, click the attachment below.