A sharp contraction, then an upswing

24 March 2020 | Markets and Economy


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Commentary by Joe Davis, Vanguard global chief economist

In only a few months, COVID-19 has spread around the world. The extreme measures being taken to help protect us and combat this spread should be positive for public health. But such a step necessarily involves a trade-off. In appropriately prioritising human health, we must shut down large swathes of the economy, closing schools and businesses and limiting human interaction. Having to do so makes it unfortunately clear that a global recession is at hand.

A deep (and we hope short) US recession

Given increased efforts to contain the spread of the coronavirus, we anticipate a sharp (but we hope short) contraction in the world’s biggest economy, the US economy, which has likely already entered into recession this month. The coming months are likely to witness a profound fall-off in the real US economy.

For some time, we have been estimating the likely impact of the virus’s spread through a number of channels including reduced trade, restrictions in supply chains, tighter financial conditions and, perhaps most significantly, social distancing measures. This latter effect is leading to a profound decline in consumer spending in the “face-to-face” sectors of the economy, namely hotels, restaurants, air travel and related activities. We expect consumer spending in the months ahead to decline at its sharpest pace since at least World War II, with clear negative implications for employment.

As shown in the illustration, the US economy as measured by real GDP is likely to contract in the coming quarter by nearly 17% on an annualised basis. This would mark the deepest quarterly decline since at least the 1950s.

We expect, however, that this could also turn out to be among the shortest recessions in history. Importantly, we assume that the need to significantly restrain activity, such as the closure of non-essential businesses, will dissipate by late in the second quarter. Under such a scenario, and with aggressive fiscal and monetary policy measures, we would foresee a rebound in growth in the third quarter to mark the end of this sharp yet short recession.

A sharp but short contraction

Sources: US Bureau of Economic Analysis historical data, Vanguard calculations.

A bear market in stocks and a ray of light

Financial markets have sold off significantly over the last several weeks, with eye-watering volatility. While we noted in our 2020 economic and market outlook that there was an elevated risk of a correction in the stock market, the speed of this bear market has certainly taken me by surprise.

A positive side, however, is that the long-term picture has brightened for equities in our view. As the illustration shows, the recent sharp downturn has brought returns more in line with the previous outlooks provided by our Vanguard Capital Markets Model® our proprietary in-house model which forecasts distributions of future returns for a wide array of broad asset classes1. As you can see, over longer periods we’ve had a fairly good record of anticipating where future stock returns would be, on average, over the next ten years.

Our forecasting accuracy results from our framework that is based, in part, on stock-market valuations. Until the pandemic, share valuations were elevated, explaining why we expected muted stock returns.

A ray of light is that, looking over the next ten years, our stock market outlook is starting to improve. The reason? The role that current valuations, which have contracted in the recent sell-off, play in our long-term forecast. Put simply, the price of most equities has become much lower than it had been, giving equities more room to grow before they reach what we’d consider to be their fair value. The theme broadly holds true for non-US shares. A similar dynamic also occurred in 2009, when the global economy was in a deep recession and stock prices were low.

Ten-year forecasts remind us to think long term

The months ahead will be trying times for all of us, as consumers, as investors and as people contending with the virus. But I have faith that there are better days ahead.

US 10-year equity market forecasts

Notes: Forecasts correspond to the 25th to 75th percentile of distributions of 10,000 Vanguard Capital Markets Model simulations for ten-year annualised nominal returns, in US dollars, based on the MSCI US Broad Market Index.

1IMPORTANT: The projections and other information generated by the VCMM 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 VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of December 31, 2019, and March 12, 2020. Results from the model may vary with each use and over time. For more information, please see the important information below.

Source: Vanguard.


The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.



Investment risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Simulated past performance is not a reliable indicator of future results.

These performance figures are calculated in US dollars and the return may increase or decrease as a result of currency fluctuations.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Other important information:

For professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). Not to be distributed to the public. In Switzerland, for professional investors only.

The material contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.  The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this article when making any investment decisions.

This document is published by Vanguard Asset Management, Limited, based on research conducted by Vanguard Group Inc. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments. It should be noted that it is written in the context of the US market and contains data and analysis specific to the US.

The opinions expressed in this article are those of individual speakers and may not be representative of Vanguard Asset Management, Limited.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority. Issued by Vanguard Investments Switzerland GmbH.

© 2020 Vanguard Asset Management, Limited. All rights reserved.

© 2020 Vanguard Investments Switzerland GmbH. All rights reserved.


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