News & Insights

The economy continues to improve, helped by the rollout of vaccines as well as fiscal and monetary support. Unlike typical recessions, this one was not born of financial factors but rather was the result of what was effectively a natural disaster. Economic activity was interrupted but much of the underlying demand for goods and services remained essentially intact. As highlighted in last month’s Investment Comments, the unique nature of this economic slowdown, and subsequent rebound, make parsing the data particularly difficult. When pandemic restrictions initially hit the economy, there were concerns it would take years for workers and businesses to heal. However, in the current quarter the size of the economy is now anticipated to surpass pre-pandemic levels and by year end GDP is expected to achieve its pre-pandemic path, if not exceed it.

According to the CDC, nearly 65% of U.S. adults have received at least one vaccination, and state and local governments continue to ease restrictions on businesses. Consumer balance sheets remain in good shape, aided by stimulus payments. Given a strong start to 2021, the National Retail Federation recently revised higher its expectation for retail sales this year, now anticipating an increase of 10.5%-13.5% versus its February forecast of 6.5%-8.2% growth. As consumers venture out categories such as beauty products have done well, as has spending on restaurants, lodging, and airlines. The Census Bureau announced May retail sales below expectations, down 1.3% from April, but up 24.4% versus a year ago.

President Biden is negotiating for a $2+ trillion spending bill centered around infrastructure. It is hard to argue with infrastructure, which explains why that word features so prominently in the bill’s marketing push. The positive economic value from infrastructure improvements may be diminished by the potential chilling effects of tax increases to pay for the bill. Investors should keep a close eye on the risk of higher corporate taxes. The market responded robustly to the tax cuts that were implemented four years ago, and from the market’s perspective it is very hard to find a silver lining in the prospect of a rollback.

Wouldn’t it be nice to get the benefits of more spending without the cost of higher taxes? The difference between outlays and tax collections is the deficit, and the government’s ability to run expanding deficits depends on its borrowing rate staying low. Bond owners have not been very demanding in recent years, but their continuing good nature is forever being tested. In early May Treasury Secretary Janet Yellen admitted that the improving economy, boosted further by a large infrastructure bill, could necessitate higher interest rates. This sounds to us like basic common sense, or maybe Macroeconomics 101, but it stirred up quite a controversy. Investors are very sensitive about interest rates, inflation, and asset prices, and the Secretary’s remarks touched off a modest stock market decline that was stemmed by Yellen quickly “clarifying” her comments, saying she was not predicting higher rates. She was only speaking hypothetically.

In the first quarter the S&P 500 returned more than 6%, a respectable start building on last year’s impressive gains. All eyes remain focused on the vaccine rollout and how quickly the economy can reopen more fully. Uncertainty persists regarding the course of the pandemic given the emergence of more contagious strains of the virus, but happily trends are in the right direction. The U.S. is on track to vaccinate three-fourths of the population by late June, though achieving that number requires overcoming vaccine hesitancy. However, much of the world is further behind, with emerging-market countries on pace to have closer to 30% of their population vaccinated by year end. Regardless, vaccine progress continues and should serve as a strong tailwind through 2021.

Helped by vaccines and trillions of dollars in government support, expectations for growth have been improving. The International Monetary Fund (IMF) recently bumped its forecast for world economic growth this year to 6% from prior estimates of 5.5%. This would represent the fastest expansion in at least four decades. Closer to home, the IMF estimates U.S. growth at 6.4%, fully recovering last year’s 3.5% contraction and then some. Economists surveyed by The Wall Street Journal anticipate momentum will continue into 2022 but slow to just over 3% growth. This would mark the strongest two-year growth in the U.S. since 2005.

Government intervention has made it more difficult to read and predict economic tea leaves. Record low interest rates not only allowed homeowners to refinance their mortgages, but companies also refinanced their debt and increased their borrowings. This extended into “junk bonds” where yields edged below 4% before rising recently. Such a rate used to be reserved for only the most creditworthy companies, which were recently able to borrow for less than 1% on a short-term basis and less than 2% on a long-term basis.

Statistics for unemployment, retail sales, and personal income must now be interpreted in the context of stimulus payments and COVID-related restrictions on businesses. Retail sales fell a stunning 3% in the month of February compared to January. However, January was up 7.6% from December on a seasonally-adjusted basis that takes into account normal patterns like holiday spending. Government statisticians struggled to keep up, as the January surge was originally reported as a 5.3% gain.

It is quite clear that as COVID-19 goes, so goes economic activity, which leads political response and tests the remarkable ability of people to adapt.

The path of the virus over the past few months is evident when examining what is surprisingly fairly solid economic data. Fourth quarter GDP grew 4%, capping a year that saw GDP fall 3.5% as large sectors of the economy, particularly travel and hospitality, were off limits to consumers. After COVID-19 case counts declined during the summer, a resurgence of the virus in the late fall and through the holidays spurred the reimposition of stay-at-home orders and retail closures for restaurants, gyms, and other gathering places. With less opportunity to move about, consumers still boosted their spending a respectable 2.5%, but this was short of what economists expected during the critical holiday season.

In 2020 governments around the world responded to COVID-induced economic shock with fiscal rescue policies that injected trillions of dollars into their economies and added similar amounts to sovereign debts. The Department of the Treasury’s Data Lab (datalab.usaspending.gov) recently estimated the total bill for U.S. fiscal relief at $2.6 trillion of stimulus plus $900 billion of tax relief, for a total of $3.5 trillion. That total grows closer to $4 trillion including the stimulus that President Trump signed in December.

On January 5, a surprise result in the Georgia Senate runoff turned what initially looked like a mixed U.S. election result into a “blue wave.” With a willing Congress behind him, President-Elect Joe Biden has promised to make more fiscal stimulus his top priority, proposing a $3 trillion stimulus and infrastructure plan.

As we wrap up 2020 it is worth highlighting what a roller coaster year it was for the market. Midway through December the S&P 500 has advanced more than 13%, a result that ap­peared highly unlikely during late March when shares fell sharply on COVID-19 fears. However, the market is forward-looking and global support in the form of fiscal and monetary stimulus has helped drive markets higher since the spring. Currently, the prospect of further stimulus combined with the fastest development of a vaccine ever recorded has boosted investor optimism and provided hope that a return to a more normal environment is on the horizon.

While several vaccines are on the way, the U.K. was the first country to authorize the Pfizer-BioNTech COVID-19 vaccine, starting distribu­tion on December 8th. U.S. health regulators authorized use of the same drug on December 11th with the first vaccinations taking place December 14th. Initial supplies of the vaccine are limited, but production is expected to increase meaningfully over the next several weeks. Pfizer shipped out three million doses initially with an expectation of 25 million doses available in the U.S. by yearend. Health workers are first in line for vaccinations followed by other higher-risk populations. Americans are expected to broadly be able to get the vaccine by the end of March

The election season is almost over, with a few disputes remaining to be resolved along with several incomplete congressional elections. Control of the Senate is up in the air, with 50 Republicans and 48 Democrats seated and two runoff races in Georgia set for early January.

Voters opted for divided rule. Democrats picked up the White House and at least one Senate seat, and retained control over the House. Republicans added one governorship and several state legislatures, sharply narrowed Democrats’ majority in the House, and likely retained a slim majority in the Senate. Neither party has run the table; both parties will have to work together to accomplish anything. This setup increases the odds of cooperation, moderation, and stability, a rarity in these partisan times.

We have a long way to go, but so far the post-COVID economy looks surprisingly robust. If colder weather does not bring a resurgence of the virus, then it feels safe to say that we are firmly on the road to economic recovery.

From peak to trough, U.S. GDP contracted by 10%, the third largest decline since at least 1910. The second-quarter average was -9%. More recently, September’s unemployment report published by the Bureau of Labor Statistics measured unemployment at 7.9%, down from a peak of 14.7% in April. This probably overstates the rebound slightly, as the labor force participation rate ticked down to 61.4% and is about 2% below its pre-pandemic levels. Some workers have stayed on the sidelines and aren’t counted as unemployed.

While the economy had a rough time in the first half of 2020, the recovery since stay-at-home orders began lifting has been much swifter than expected. GDP contracted at an annualized rate of 31.7% in the second quarter but since June has rebounded strongly. As of September 16th, the Federal Reserve Bank of Atlanta’s GDPNow third quarter GDP estimate calls for annualized growth of 31.7%. Continued recovery will depend on the rate of new COVID-19 cases that, for the most part, have continued to decline, encouraging states to loosen restrictions on service-based businesses such as restaurants and gyms.

Other economic indicators confirm the recovery while at the same time differentiating the impact of COVID-19. The August Institute for Supply Management index of manufacturing rose to 56 from 54.2 in July, extending its rebound since the 41.5 level of March (above 50 signifies growth, lower than 50 contraction). Commerce Department figures show that monthly spending on goods for July is 6.1% above February’s peak level while spending on services has fallen 9.3%. This dichotomy reflects pent-up demand for goods that would have been purchased during business lockdowns while also reflecting the inability and/or lack of desire of consumers to purchase services like air travel, restaurant meals and haircuts.