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U.S. Economy Closes Out 2020 "less bad" Than Expected

U.S. Economy Closes Out 2020 “less bad” Than Expected

The market has been choppy the last few days as investors digest the initial weaker than expected 4th quarter GDP growth of 4 percent and the recent remarks by Federal Reserve Chairman Jerome Powell.

However, the news is not as dire as it may appear.

The following quarterly Gross Domestic Product (GDP) chart shows how dramatic 2020 has been due to the impact of Covid-19 on the economy.

This is “less bad” than expected during the first half of 2020, when the economy was shut down.

Below is the Gross Domestic Product (GDP) forecast by the Wall Street Journal based on surveying a group of more than 60 economists. The May 2020 forecast (below, in blue) anticipated the economy would contract 6.6 percent during 2020. It now looks like the 2020 GDP contraction will be 3.5 percent (in green), which is “less bad.” Economist are forecasting 2021 US GDP to grow a robust 4 to 5 percent with the roll-out of the Covid-19 vaccination.

Another screaming headline is that “Coronavirus Slump Is Worst Since Great Depression. WSJ – 5.10.2020.” This is an exaggeration.

Below is the annual GDP since we started measuring it. By comparison to 2020, GDP contracted 25 percent during the first 3 years of the great recession, and 14 percent during the worst year of World War II. I do not mean to minimize the loss of jobs by workers in the hospitality, travel and other industries or the 441,000 and counting Covid-19 deaths in the US. However, a 3.5 percent contraction in the economy is certainly less bad than the 25 percent contraction over the first three years of the great depression.

What does this mean for the stock market?

A recent study by Dimensional showed that the stock market is more correlated with GDP in subsequent periods, than the current one. This implies that investors are looking ahead to the second half of 2021 and the beginning of 2022. In addition, studies show that the near-term future of the stock market is unknowable.

I recommend we stick to our respective target equity allocations and continue to rebalance when we deviate widely from our target allocations. This strategy rewarded us during the Covid-19 stock downturn and there is no reason to abandon our financial discipline now.