Whether we have seen the worst effects of the global coronavirus pandemic is still too soon to determine. What we do know is that the second quarter of 2020 presented a monumental economic challenge to American investors, consumers, employers, government agencies, and workers, and we see this reflected in the data. Unemployment remains high, and consumer sentiment has slumped.
The Commerce Department reported the U.S. gross domestic product in the second quarter fell at a seasonally inflation-adjusted annual rate of 31.4% or fell by 9.1% on a quarterly basis unannualized. The figures represented the steepest declines in more than 70 years of record-keeping.
The second-quarter economic contraction came amidst state-imposed lockdowns to control the spread of COVID-19 in March and April, triggering a steep drop in output. Lifted restrictions in May and June allowed growth to resume, but there remains a long way back. The historic drop in output reflected the worst months of the pandemic-related shutdowns and followed a 5.0% annual contraction in the first quarter which marked ended the longest expansion in U.S. history.
The gains later in the second quarter were not enough to offset March and April’s steep drop. Economists expect the third quarter, which began on July 1, to show growth, though the summer rise in infections is likely to temper gains, and autumn’s spikes in COVID-19 cases continue to threaten a derailment of any recovery. Many states have had to pause or roll back reopening plans to deal with new coronavirus cases, weighing on economic activity.
Spending took a plunge, saving increased
The decline in GDP in the second quarter reflected the deep hit to consumer and business spending from the lockdowns, social distancing, and other initiatives aimed at containing the virus.
Consumer spending fell at a 34.6% annual rate amid sharp decreases in expenditures on services such as health care, recreation, and food. Consumer disposable income rose 9.2%, even though total wages and salaries dropped 7.1%. Consumers hedged against the economic uncertainty by saving 25.7% of their income, a big leap from the 9.5% rate in the first quarter.
Business spending on software, research and development, equipment, and structures fell at a 27% annual rate. Both exports and imports plummeted. Spending by the federal government rose by 17.4% as it paid out fiscal stimulus checks and supplemental unemployment benefits. State and local government spending declined 5.6%.
But while real output posted a catastrophic drop in the second quarter, disposable personal income surged at an unprecedented 44.9% annual rate. Stemming from the $2.2 trillion CARES Act stimulus package passed in March, current transfer receipts from the government skyrocketed, including expanded unemployment payments, one-time economic impact payouts to individuals, and other social benefits. Personal current taxes declined.
With most economic activity still subdued and much uncertainty about the path of the virus and its impact on growth, households saved a large share of their income. The personal saving rate surged to a record 25.7%. The federal Paycheck Protection Program, which provided loans and grants to small businesses, partially offset the decline in proprietors’ income.
Personal income—what households received from salaries, investments, and government aid—fell 2.7% in August as enhanced unemployment checks shrank, according to the Commerce Department. Consumers increased spending over the summer as they made up for purchases, they put off during the spring; they bought goods such as bicycles, cars, and groceries while investing in home improvements. But the August boost to spending of 1% was far smaller than earlier in the summer when spending grew 9% in May, 7% in June, and 2% in July. Spending on services—such as restaurant outings, hotels, and air travel—remains depressed.
The U.S. personal savings rate has been running between 6% and 8% over the last five years. In April 2020, it blipped up to 33.7% as a result of the stimulus package and lower spending during lockdown. As the economy reopened and consumer spending picked up, the savings rate began to decline and was at 14.1% in August.
Jobs Lost
When the economy started shutting down during the early phases of the coronavirus pandemic in March, economists argued that the bulk of the job losses would be temporary as these workers would be recalled once businesses were cleared to reopen. Indeed, the economy has experienced a partial snapback from the depths of the crisis. But seven months later, many businesses remain closed. Many have gone bankrupt. And the effects of the prolonged economic pause are rippling out in the form of real economic pain.
Initial jobless claims remain over 800,000, three times larger than the historic average. In the U.S. payrolls report for September, 3.75 million American workers were identified as permanently losing their jobs, up from 3.41 million from the previous month and 1.28 million in February before the lockdowns. Meanwhile, those on temporary layoff fell to 4.64 million in September, down from 6.16 million in August and 18.06 million in April. If we add in those on temporary layoff for 27 weeks or longer, the rate of permanent unemployment would be about one million higher at 4.5 million.
While job growth continues at a more moderate pace and unemployment continues to trend down, this dynamic bears close observation because permanent layoffs can lead to longer unemployment durations and slower rate of hiring. The cumulative increase in payrolls since the April low is now 11.4 million, recovering just over half the 22.2 million peak-to-trough plunge that occurred after COVID-19 struck. But the rate of improvement has clearly slowed as the resurgence of the virus has constrained the pace of reopening. The early signs for October have not been encouraging, even before the recently announced reductions by American Airlines, United Airlines, Disney, and Allstate, which have announced layoffs totaling 64,000 people.
Different ways of measuring GDP can blur the picture
When the Bureau of Economic Analysis reports quarterly GDP, the agency presents the data in several different ways to aid in analysis.
Among them, GDP is presented as:
- A percentage rate of growth or contraction from one quarter to the next. This figure was minus-9.1% in the final second-quarter GDP report.
- A percentage rate of growth or contraction in the quarter on an annualized basis. This was the -31.4% figure in the final second-quarter GDP report.
That latter annualized rate projects how much the economy would grow or shrink if the rate of change seen in the quarter continued at the same pace for four consecutive quarters, with some adjustments for seasonality and compounding effects. There are reasons to look at GDP on an annualized basis. When the economy is operating more normally than it is now, annualizing helps compare the quarter-to-quarter rate of growth for two different periods and understand in which the economy was expanding at a greater annual rate.
The trouble with this annualized GDP reading is that big outliers can create very distorted annualized readings. As the New York Times put it, if you got a $500 bonus one month, you wouldn’t think of it as a “$6,000 raise, on an annualized basis.” One-time windfalls such as bonuses or one-time economic disasters such as the second quarter of 2020 cannot really be translated into a long-term trend.
In all likelihood, measurements of U.S. economic output in the third or fourth quarter will reflect a rebound that translates into an unrealistic annualized growth rate—a rate that the economy is just as unlikely to achieve as it is currently likely to suffer—based on second-quarter figures. The second quarter of 2020 was dismal for U.S. economic output. The pace at which the economy contracted was by far the worst in recent memory. In fact, it was the worst rate since at least 1947, with only four other quarters in the past 100 years showing greater declines in annualized U.S. economic output.
How is the market doing?
In recent years, the performance of the biggest (market capitalization) stocks have moved in lockstep with the average stock. That is still the case this year outside the United States. But, in the U.S., the biggest stocks have outperformed the average stock by a wide margin this year. Increasing dependence on a small number of big stocks for overall performance can be a sign of vulnerability.
The five largest stocks in the S&P 500—Apple and Microsoft (Technology), Google/Alphabet and Facebook (Communication), and Amazon (Consumer Discretionary)—have received a lot of investor attention. In equal-weighted terms, they represent 1% of the S&P 500, but in cap-weighted terms, they now represent nearly their own quartile (25%). This cycle’s dominance by the top five stocks is outsized relative to past cycles. Following the past three major bear market lows, the five largest stocks did not perform as well as they have today.
The dominance by “big tech” has also created a wide gap between the S&P 500 and its mid- and small-cap companion indexes, the S&P Midcap 400 and the S&P SmallCap 600, which this year are minus-3.0% and minus-9.0%, respectively. Meanwhile, the S&P 500 is up around 8% for the year. Despite the S&P 500 being up, less than 10% of both the NASDAQ and the S&P 500’s members are trading at a new 52-week high. Interestingly, the Technology sector has not been only stronger, but also less volatile than most other sectors.
In the joint history of the S&P 500 and NASDAQ, there is no other five-month period when the S&P 500 was up more than 50% and the NASDAQ was up more than 65%. Whether these recent all-time highs will follow with more of the same, represent “double-tops,” or show something in between is yet to be seen. That said, it would be in keeping with history for at least some short-term consolidation, which could simply take the form of a rotation away from the concentrated leadership areas. Most historical studies of similar periods of concentration show a tendency for flat-to-lower stock prices short-term but higher prices longer-term.
However, within the entire population of the United States, fewer than 52% of families own stock. They can own it through a taxable brokerage account or a retirement account, but only 51.9% own any stock whatsoever.
The telling statistic to look at is how stock ownership changes based on percentile of usual income. (Source: Federal Reserve’s Survey of Consumer Finance for 2016)
In the top 10 percentiles of income, 94.7% of earners own stock.
In the 80-89.9 percentile of income, 85.3% of earners own stock.
In the 60-79.9 percentile of income, 73.6% of earners own stock.
In the 40-59.9 percentile of income, 51.8% of earners own stock.
In the 20-39.9 percentile of income, 32.5.6% of earners own stock.
In the bottom 19.9 percentiles of income, just 11.6% of earners own stock.
Warning signs from the Fed
In the six months since the coronavirus pandemic gripped the U.S. economy, the Federal Reserve has reached far beyond its playbook from the Great Recession, growing its balance sheet by roughly $3 trillion through emergency lending programs and moves to bolster the markets. The vast emergency response helped stabilize a stock market jolted by the rapidly spreading virus. The Fed’s emergency actions are keeping credit flowing in ways that Fed leaders say have prevented an even deeper financial crisis.
Fed chairman Jerome Powell told the House Financial Services Committee in mid-September that the expiration of Congress’ coronavirus stimulus will weigh on the U.S. economy.
“What’s happened lately is that the economy has proved resilient, both to the broader spread of the [coronavirus] … and also to the expiration of the CARES Act benefits,” Powell said. But while the economy tries to recover from the pandemic’s pummeling, he added, the economy will eventually feel the negative effects of these measures expiring.
Data show the economy and labor markets have improved since the onset of the pandemic. Still, 11 million more people remain unemployed compared to before the coronavirus hit. “That’s a long way to go” for recovery, Powell noted.
Unemployed Americans over time go through their savings because they have not yet found a job and have no financial cushion to fall back on. “Their spending will decline … and so the economy will begin to feel those negative effects at some time,” Powell said. He also said the recovery “will go faster if it’s all government working together”—a signal to Congress to step up and pass another stimulus package.
Legislative action has been scrambled, however, with President Trump offering mixed messages on negotiations and the congressional Republicans and Democrats at odds over what a new package would contain.
Where are we going from here?
The economy up to now has rebounded more quickly than many economists thought. But with the prospect of federal aid fading and job growth slowing, consumer spending—the key driver of economic activity in the U.S.—could weaken.
Economists believe the recovery is entering into a modest and more grinding phase. Momentum has stalled. Six months into this crisis, we are still a long way from getting back to pre-pandemic conditions. Weekly claims for unemployment benefits are still about three times higher than they were before the crisis. At that level, they also remain higher than any other period prior to the pandemic, in records going back to 1967.
The travel, leisure, and hospitality industries have been hit particularly hard. Restaurants are seating 35% fewer customers than they did before the pandemic. Hotel occupancy is down 30%, and airline travel, as measured by travelers through TSA checkpoints, is down about 70% since early March. And although some movie theaters have reopened, they’re barely operational: box office sales are still down about 90% from where they were before the pandemic. The British-based Cineworld Group Plc, which owns Regal Cinemas, the second-largest chain in the United States, has closed all 536 of its American movie theaters until further notice, affecting about 40,000 employees. The largest cinema chain, AMC Entertainment Holdings Inc. said in a filing that it could run out of money by the end of 2020 or early in 2021. AMC is looking to boost liquidity through asset sales, renegotiating leases, joint ventures, and debt or equity financing; though the company is pessimistic about staving off bankruptcy, it’s not in AMC’s plans at the moment.
Against this dismal backdrop there are only a few bright spots: stocks, housing, and e-commerce.
Stocks, as noted above, are owned by a relatively well-off segment of the population, and while they have benefited, it could mean a K-shaped recovery leading to a widening wealth gap. As former Fed chair Janet L. Yellen told the Washington Post, “[the] stock market isn’t the economy. The economy is production and jobs, and there are shortfalls in virtually every sector of the economy,”
The housing market has boomed in some pockets of the country, driven by record-low interest rates, new work-from-home policies pushing some city dwellers to look for cheaper homes outside urban areas, and a definite lack of inventory. That said, it is unclear how much longer strength in the real estate market can continue.
E-commerce retail sales, as tracked by the Commerce Department, have already surpassed their pre-pandemic level. But that V-shaped recovery has been driven mostly by one category: non-store retailers, which includes online shopping. The services industry and brick-and-mortar retailers—particularly clothing stores—are still operating well below their pre-pandemic levels, and many are expected to shutter. Yelp recently reported that as of August 31, nearly 163,700 businesses on the reviews site had closed since March 1. Of those, about 98,000, or 60%, said they have shut their doors for good.
Third-quarter GDP is expected to be released on October 29. The consensus estimates are for an annualized gain of 30%. But as we discussed above, it’s the levels that matter. Even with a positive 30% annualized increase in the third quarter, we are not getting back to the levels we saw at the end of the first quarter 2020, much less the pre-crisis levels, in terms of GDP dollars until late into 2021, or perhaps even 2022.
Forecasts are for a low single-digit growth rate in the fourth quarter and a negative growth rate of 3.5% to 4% for 2020, but those forecasts depend on two factors: the pandemic doesn’t get worse and fiscal policy comes to the rescue.
Right now, the outlook does not look great on either front. After weeks of declines, coronavirus cases are on the rise again in the U.S., just ahead of colder weather and flu season, while lawmakers remain locked in a stalemate on another fiscal stimulus package.
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