Morgan Stanley
  • Wealth Management
  • Aug 3, 2020

How Spike in COVID-19 Cases Affects Investment Outlook

U.S. stocks rose in July, even as the pandemic spread. Here’s why we still forecast an economic rebound.

There is no getting around it. July was a very sad time for the U.S. and its economy. The daily average of new COVID-19 cases surged to nearly 75,000 from about 25,000 in May and June, and cumulative deaths exceeded 150,000. Some states slowed or rolled back reopening plans, and a number of economic readings deteriorated. Most notably, the improvement in unemployment claims has stalled and a key indicator of consumer confidence missed expectations.

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Nonetheless, the market was broadly stable, with the benchmark S&P 500 rising by about 5% in July—to nearly flat year-to-date. Better-than-expected second-quarter earnings have helped, as have extremely low interest rates; but I am still getting a lot of questions about why we see a V-shaped economic recovery ahead, despite the disheartening trajectory of the pandemic.

To be sure, second-quarter U.S. GDP contracted by an annualized 33%—the worst on record. Yet, other economic readings suggest that the government stimulus package so far may to be working to help bridge the crisis for many consumers and businesses. The household savings rate, for example, has soared, and retail sales are improving, while personal incomes overall fell only 1%. 

Credit Backstop

Meanwhile, the Federal Reserve’s additional liquidity has allowed many companies to restructure their debt and reduce default risk. Lending programs, like Paycheck Protection Program loans, offered many businesses a financial backstop. We also remain confident that more stimulus is coming and forecast a base case of about $1 trillion in additional government spending by the end of August.

Looking ahead, we expect the data on manufacturing, capital goods investment, housing and consumer durables to keep improving, potentially forming the core of the V-shaped recovery. Those sectors can support small and midsized businesses through the restoration of supply chains. Even more important, the housing rebound is running at its best pace since 2007, as 30-year mortgage rates fall to new lows.

Certainly, delayed business re-openings will continue to drag on already depressed sectors, such as transportation, hospitality, restaurants, recreation and other direct consumer services, which make up 15% of GDP and employ a large number of people. But, since demand in those sectors all but hit zero in the second quarter, the third quarter will likely show improvement.

Global Momentum

Similarly, the 63% drop in the healthcare sector, which makes up about 12% of GDP, accounted for about one-third of the total second-quarter GDP contraction. As elective medical services resume, the pent up demand for everything from dental care to hip replacements could give the healthcare sector a significant bounce. Indeed, the “worst ever” GDP reading could be followed by the “best ever” growth, at least on a quarterly basis, in the third quarter.

A final point in our V-shaped recovery thesis involves improving dynamics outside the U.S., which I discussed last week. Global trade may have bottomed, and recent gains in commodity prices could signal a pickup in both demand and investment. The weaker dollar should benefit countries that issue dollar-denominated bonds (many emerging markets), by making their debt less expensive to repay. The momentum from a sustained global economic recovery may help lift U.S. growth.

Market positioning in the U.S. remains defensive under the surface. However, we see manufacturing and housing leading the recovery and suggest that investors tilt their asset allocation toward cyclical sectors, as well as non-U.S. markets, especially those poised to benefit from global grade, such as Asian emerging markets.

Meantime, we will be monitoring the fate of a new fiscal stimulus package and waiting for improvements in virus management.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Aug 3, 2020, “COVID-19 Spikes and the Investment Narrative.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report