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Principal Global Investors

Economic Insights: A push to reopen
Update for the Month of May, 2020
Commentary by Robert F. Baur, Ph.D., executive director, chief golobal economist
The recession from Covid-19 mitigation roared into reality withApril reports. United States and Euro area business surveys anddata showed huge declines. But China’s economy reopened asvirus injury faded. European countries have been restarting for
two weeks and some U.S. economic activity is ticking higher.
April stock markets looked past the crisis to recovery; markets
were boosted by monster fiscal and monetary relief packages. A
few months of equity relapse or consolidation is likely until theshape of the economic rebound becomes clear.

Tiptoeing into recovery
The U.S. and Euro area recession that was obvious after
pervasive business closures and lockdowns has been ugly.
Business surveys plunged with service companies hit harderthan manufacturing. First quarter Eurozone gross domestic
product (GDP) plummeted 3.8% from the prior quarter, astaggering loss which doesn’t yet include the worst phase.
In the U.S., more than 30 million people applied for joblesscompensation in the last six weeks, a number without historicalparallel. March U.S. consumer spending tumbled 7.5% fromFebruary, a stunning 61% annualized nosedive. More dreadful
data will be coming, but it’s expected; the reports will be stale.
The real news is how different this contraction is from what’stypical. A recession is usually caused by problems createdduring the economic expansion that preceded it. Interest rates
rise; inflation soars; profits plunge; defaults, bankruptcies surge;
layoffs begin. That’s the normal sequence.
This recession resulted from a desire to constrain a medical
danger by closing businesses and pushing people to avoid
crowds. Since the cause was unique, it’s likely the downturn andaftermath will be quite different (see "Four ways this recessionis unique").
Some of these differences can be an advantage. Confidence
falls to really low levels if the layoffs, problems, and defaultsof the recession drag on and on. But, in a short downdraft,
consumer sentiment should hold up much better. And it is;recent surveys show household confidence, while down fromthe peak, remains well above the sour level of the financial crisis.
Further, in a classic recession, it’s often months before anyone
is aware it’s started. As a result, official action to lessen thedisruption arrives late. This time, the onset was so obviousthat the U.S. government set up gigantic monetary and fiscal
relief packages up early and fast. So, the income lost during theclosures could be made up fairly quickly.
In this environment, economic forecasts depend on Covid-19contagion. That pattern was established earlier in China andSouth Korea. It’s a two to three month rise and fall in daily new

Four ways this recession is unique
1. Deeper, a much bigger loss of GDP: We’re not visiting
restaurants, gyms, or airports less frequently … we’re notgoing at all!
2. Selective in who it hurts: This is a small business recession
concentrated in service industries. Manufacturers areholding up better. Some large companies are hiring big
numbers of people.
3. Shorter: It will likely follow the three-month pattern ofvirus activity.
4. Obvious onset: As businesses closed and people stayed
home, a recession was guaranteed.
virus cases and fatalities. Euro area countries are following thatframework. Daily new cases and fatalities topped in Italyin lateMarch and Spain and France in early April.1 In the U.S., daily
new cases and fatalities have flattened and trended lower since
mid-April, likely the peak.
Many people worry about a second infection spike in Japan andSingapore. But a closer look at the data suggests the first wave
was just slightly extended. New cases and fatalities are fallingnow, and adjusted for population, are very low.

Looking ahead at reopenings' modest effects
With cases and fatalities receding, officials turn to reopening.
It will likely follow the shape of activity in China. Businesses
there have restarted operations but are not necessarily atcapacity. For example, 98% of Starbucks stores are open.
Leaders at Caterpillar noted that all of its facilities in China areoperating. Traffic monitors show rush hour traffic is mostly
back to normal. Official April business surveys showed further
mild expansion and a modest improvement from March. The
National People’s Congress is scheduled for May 22, a vote ofconfidence in mitigation.
While businesses have mostly restarted, China’s households
stay cautious. Weekend traffic, mostly consumers, improved
but remains below normal. Restaurants are open, but seats are
empty. Vehicle sales bounced off the bottom but are well below
normal. March industrial output was only 1.1% below a year
ago, but retail sales were 15.8% under last year, a minor gain
compared to the January–February loss of 20.5%. Households
in the U.S. and Europe will surely mirror this wary attitude evenas activity picks up.
Euro area countries are about two weeks into gradualreopening. Sweden, for example, did not have a general
lockdown. Austria, Denmark, Norway, and the Czech Republic

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here.

began to restart a bit earlier. The revival brought no new infection
spikes so far.

an excruciating loss of 33.9% from the peak of February 19. Bond
investors experienced similar reversals. Whipsaws happen.

U.S. resumption is underway. Some high frequency data alreadyshow gains. Motor gasoline demand has recouped about a fifth ofits drastic loss from mid-March. Applications for home purchasemortgages recaptured a fourth of their plunge. Smith Travelnotes that U.S. hotel occupancy nudged up to a still horrid 26% inearly April. TSA travel counts have risen a bit after an earlier 96%
plummet. J.P. Morgan researchers point to tentative increases
in “requests for driving directions in Apple Maps, global flights
tracked by FlightRadar24.com, consumer spending tracked
by 1010data.exabel.com, and restaurant revenues tracked byWomply.com.” Some of these are anecdotal, but it’s clear people
want a semblance of normalcy.

Equities were buoyed by the super-fast Fed response: theimmediate fed funds rate drop to 0.0% to 0.25%, the colossal
backstop of U.S. bond markets, and the eventual expansion of all
Fed support. Added fiscal spending well north of $2 trillion, plus
talk of even more, enhanced the rally.

Data for second quarter growth in greater Europe and the U.S. willshow monster contractions due to April lockdowns and closures.
U.S. monthly reports should show decent progress in May anda solid revival in June, followed with a sharp rebound in July andAugust. We expect a mammoth plunge in U.S. GDP of 20% to25%, annual rate, this quarter with a snappy third quarter recoil
near 10% up.
Beyond that, the U.S. recovery will be protracted. Some small
businesses will never reopen regardless of fiscal relief. As in China,
fear of infection will linger and the desire for more savings will
trim any spending boom. The jobs lost during the crisis may not
be fully replaced until early 2022. Late this year and early next,
growth should be 3% or so, dwindling back to trend the rest of2021, subject to whatever harm the virus may create next falland winter.
We expect the Eurozone revival to be less substantial and moredelayed. The rate of virus infections and fatalities was very highin Italy, Spain, and France and the closures particularly severe.
Disagreements over the contours of fiscal policy have maderelief slow in coming and less generous than needed. Help forbusinesses is the forte of the European Central Bank (ECB). Itsloan programs and bond purchases were massively scaled up.
While third quarter Eurozone growth will surely be positive, therebound will be more lackluster than hoped.
We’ve gained some clarity on the questions listed last month.
China’s relationship with other countries has markedly
deteriorated. Widespread questions about the true source ofthe original infection will keep any rapport at a low ebb. It will
be difficult for China to broaden its alliances in Asia and Europe.
The danger of far-flung supply chains for certain goods likepharmaceuticals has become evident. So, the ongoing antiglobalization trend may intensify. Some of the lifestyle questions,like working from home, online schools, brick and mortar stores,
will take more time to sort out.

Focus on markets
For most investors, April returns were nearly the opposite of ahorrid March. All the markets we track, except Mongolia, had again in April; the Nasdaq Composite was second of 47, up 15.4%.
Those who owned the S&P 500 Index had a gain of 12.7% inApril after a March loss of 12.5%. From the March 23 low, theygained a healthy 30.2%. Of course, that was only after enduring

The huge upturn since late March says investors are looking past
the crisis and focused on earnings gains from reopening. History
shows that stocks often retrace 50% to 62% of the loss from asharp decline. The S&P 500 Index close on April 29 hit the upper
end of that range. Further, first quarter earnings estimates for
the S&P 500 Index have already plunged but may still be too
optimistic given the economic data to come. Current estimates for
only a small decline this second quarter also seem far too hopeful.
And until the last week of April, the rally was too narrow, driven
only by past leaders. This all suggests any further up move will bevery difficult. Much of the eventual improved growth and virus
news is already priced in.
We are now just past the worst phase of recession. As growth
picks up in summer and fall, equities should be able to movemodestly higher. Because so much future growth and uptrend
potential is priced in, we expect a period of relapse andconsolidation through June. Even though stocks often retest
recent bear market lows after an initial upsurge, the S&P 500
Index trough of 2200 seems well out of reach given the enormityof the Fed’s backstop. Earnings pessimism should return at somepoint and we can envision a relapse to 2600 or below, a likely goodentry point for those underweight stocks.

What to do with your investments?
For one or two months, we like large cap growth and tech stocks;
those past leaders should continue to outperform as markets
consolidate and thrash about before the next move higher. If
growth returns, the uptrend should broaden out to include a wider
group of winners. On a six-to nine-month basis, we like stocks
that do well when growth accelerates: small caps and sectors likeenergy, materials, consumer discretionary, financials. With the U.S.
dollar likely to weaken, we prefer select emerging market stocks
over those in developed countries outside the U.S.
For bonds, the Fed and other central banks will keep shortterm rates at super low levels for a long time, surely throughmost of next year. Even long-term U.S., German, and Japanesesovereign bond yields will stay low with massive central bankbond purchases. However, those long-term yields could be undermodest upward pressure later this year as growth improves. That
steeper yield curve would be good for financial stocks. We advise
avoiding long-maturity safe-haven bonds.
With nearly unlimited Fed backstops for investment grade
and some municipal and high-yield bonds, credit spreads areunlikely to widen much further. We like the higher yields on highquality corporate and municipal bonds at short to intermediate
maturities.
All these suggestions are tactical, short-term in nature. This is nota time to make long-term investment decisions. It’s possible that
equity returns, even over several years, may not be very rewarding.

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here.

One reason to be wary is that recessions have a job to do: cleanse the economy of imbalances, eliminate debt, scare people into frugal
behavior, and move assets from weak to strong hands. That won’t happen in this atypical recession; problems existing before
the recession will still be challenges after. Total U.S. economy-wide profits have been flat for five years, profit margins shrinking.
Thus, there’s potential for a second downturn after the rebound, perhaps late next year or 2022. This is not a prediction, more areminder to consider the odds of a surprise double-dip or unexpected earnings decline over the next couple of years. We’re still fully
invested for now. Be positive for this year but stay vigilant for a major change in the investment framework.
1All Covid-19 data is from Worldometers.info/coronavirus.

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