Editor's note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.
The U.S. economy took it on the chin in March as the coronavirus-related shut-ins took their toll on consumption, especially across services-related sectors. Overall economic growth in the United States, as measured by real gross domestic product, contracted at an annualized rate of 4.8% during the first quarter of 2020. This is the greatest decline since an 8.4% contraction during the depths of the global financial crisis in the fourth quarter of 2008. However, the GDP release was largely disregarded by the markets as this contraction was widely expected and is near the middle of Wall Street forecasts, which had ranged anywhere from flat to down 11%.
Rather than dwell on the historically bad GDP number, market participants focused on positive news in the fight against COVID-19 and some better-than-expected first-quarter earnings results such as those from Alphabet GOOG. The good news announced this morning consisted of results from a study by the National Institutes of Health that Gilead’s GILD drug remdesivir met its primary endpoint. Patients on this drug recovered faster and had a lower mortality rate than those on a placebo. While we are awaiting more details from this and other studies, we think the FDA will approve this drug by midyear.
In our outlook for 2020, we anticipated that drug treatments such as Gilead's will be rolled out in the summer, and we continue to expect that targeted antibody treatments will be implemented by the end of the year and that a vaccine will be available in 2021. In this scenario, the first-quarter release itself isn't enough to move the needle on our 2020 forecast for the U.S. economy. We still think that U.S. real GDP will decline by about 3% in 2020. This incorporates the impact of widespread nonessential business closures and voluntary social distancing, which we believe will crest in the second quarter. Much of the economy has remained up and running throughout the closures. Also, the historically large fiscal stimulus being deployed in the U.S. should help contain the economic damage. More importantly, we think the long-term economic impact will be modest: a less than 1% decrease in long-term economic output. Still, we caution that investors should be prepared to see even greater economic contraction during the second quarter before we see significant expansion in the second half of 2020.
The average Wall Street forecast for second-quarter U.S. GDP is a 25% decline; however, the range of estimates varies widely between a 10% and 45% decline. It should be noted that these declines are annualized results and that the nominal quarterly decline is approximately one fourth of the headline number. For the full year 2020, the average forecast is for a 4% decline (more than our 3% projection), but the individual forecasts that underlie the average range anywhere from positive 1.7% to negative 10.8%, indicating a wide range of uncertainty on near-term economic activity.
Additionally, the Federal Reserve's Open Market Committee published its press release following its April meeting and Federal Reserve Chair Jerome Powell held a press conference. As expected, there were no new major policy changes or programs announced. The Fed held the federal-funds rate steady at a range of 0%-0.25% and committed to purchase U.S. Treasury bonds and mortgage bonds to support smooth market functioning; however, we note that the asset purchases have declined meaningfully from $75 billion per day during the third week of March to only $10 billion per day this week, and they are likely to dwindle from here. The Fed has already instituted a combination of traditional monetary policy actions, nontraditional programs, and new initiatives to help mitigate the impact of the COVID-19 shut-ins to the economy. The Fed is now in the process of switching gears from concentrating on supplying liquidity to keep the markets from freezing up to providing the credit that will be needed to transmit its low interest rates to consumers.
Even though economic activity will contract significantly in the second quarter, we expect the economy will recover in the second half of the year, that positive momentum will carry into 2021, and that the long-term impact to the economy will be minimal. As such, we continue to see value in both the equity and corporate bond markets for long-term investors. As we noted in "Time to Take a Breath and Re-Evaluate," the median stock under our research coverage is still trading at a discount to our fair value estimates; however, Morningstar's Market Fair Value metric has risen to 0.93 from 0.70 on March 23, reflecting that much of the easy short-term returns have been made. This sharp rebound highlights the need for long-term investors to stick with their targeted asset allocations within their risk tolerance levels, especially during periods of market turmoil. Like the rebound in the equity markets, corporate bonds have also recovered much of their earlier losses. Yet, even following this rebound, corporate credit spreads remain wider than their long-term averages. As we highlighted in "Risky Assets Reduce Fixed-Income Returns,"we continue to think this may be an opportune time to rebalance fixed-income portfolios and layer in additional corporate-credit fund exposure.
Disclosure: This article has been written on behalf of Morningstar, Inc., and is not the view of DBRS Morningstar.