As 2020 has ended, we began to look forward to 2021 in hope the year arriving will be better than the one just departing. How could it not be, after months filled with pandemic, toxic politics, and violence in the streets?
What do we anticipate for the economy in 2021? Given the promise of the vaccine’s arrival, we think U.S. economic growth will respond healthily during 2021. The rate of growth will be soft at the start of the year but will rebound as vaccination facilitates economic reopening. An average of economists’ expectations for U.S. growth in 2021 is 4%, with most of that back-end loaded for the third and fourth quarters.
Shapes of Things to Come
Economists and analysts have proposed multiple letter-based geometric characterizations describing recovery in the economy and stock market (the two are not equivalent). These characterizations include a V-shape for the stock market’s recovery, a W-shape for the ongoing fits-and-starts of economic activity, and an L-shape for many parts of the leisure/hospitality industries.
We think the letter shape that best characterizes the unique implications of this health crisis-turned-economic-crisis is a K. This depiction describes a recovery in which a portion of businesses and the population’s health comes back quickly and fully, while another portion continues to suffer a great deal.
Given the impact of COVID-19 on the restaurant, bar, travel, and hospitality industries, a K-shape recovery seems likely for the U.S. Half of the jobs in the leisure and hospitality industry vanished in April alone, and only a little over 50% of those lost jobs had come back by December. The leisure and hospitality industry employs 1 in 9 workers while paying some of the economy’s lowest wages in comparison to industries such as technology and some segments of retail (which have not just recovered but are doing better than before the pandemic hit). The diverging strokes of the letter K represent the vastly differing fortunes of the haves and have-nots following the deepest recession in decades.
Still, as joblessness surged in 2020 and many households struggled to pay the bills, many Americans were able to work from home and benefit from a sharp rise in asset values. Unprecedented stimulus from the Federal Reserve kept mortgage rates low and encouraged investors to buy equities.
The National Bureau of Economic Research analyzed what people did with the first set of stimulus checks they received. It shows that almost 40% of the respondents did not spend any of the money they received; they saved it or paid down debt. Yet, at the other extreme, almost 30% spent the entire amount on durables, food, medical supplies, and other consumer products. The remaining 30% plus had a mixture of spending and saving. Those that needed the stimulus checks to make ends meet or to try and survive spent it all, while at the other extreme the payments were a windfall.
Divergent Boundaries
The pandemic unleashed massive divergences within the economy and the stock market. Some of these divergences persist, including:
- Rising permanent job losses vs. declining temporary unemployment
- Ease for many higher-income workers to work remotely vs. lack of flexibility for lower-income workers.
- Stronger trends in goods production/consumption vs. weaker services
- Booming residential real estate vs. beleaguered commercial real estate
- Flourishing online retail vs. hard-pressed brick-and-mortar retail
- Strong money supply growth vs. weak money velocity
Other divergences unleashed by the virus are beginning to converge, including:
- Big 5 stocks’ outperformance relative to the other 495 within S&P 500
- Options market speculation vs. traditional mutual fund/ETF flows
- Stay-at-home stocks vs. get-out-and-about stocks.
As is the case with many individual economic data series, a V-shaped recovery appears from the bottom; but only about two-thirds of the contraction brought on by the pandemic has been retraced. The same can be said about overall gross domestic product (GDP): after contracting by minus 5% in the first quarter and minus 31% in the second quarter, it rebounded by plus 33% in the third quarter (on a quarter-to-quarter annualized rate). Of course, the way math works, the third quarter jump did not fully retrace the prior contraction, and GDP is also only about two-thirds of the way back to a full recovery.
What Next?
The pandemic’s long-term impact on consumer behavior is not fully understood. How quickly will the affected industries recover in 2021? We may not have a full picture until, quite possibly, 2022. Although most global economies saw a relatively rapid economic rebound from the initial onset of the pandemic, the world still has not returned to normal. As 2020 approached its end, a major spike in COVID‑19 cases in the U.S. and Europe posed a renewed threat to the recovery.
Looking ahead to 2021, we believe we will see another dip in economic activity courtesy of the resurgent virus and implications of mandated, as well as self-imposed, lockdowns. Consumer sentiment is one of the biggest risks for the market. This does establish greater vulnerability to the extent there is a catalyst.
However, assuming the new vaccines can be distributed on an accelerated scale, especially to higher‑risk populations, economic conditions could improve rapidly in the second half. But courtesy of the coming vaccines, the outlook beyond the near-term is brighter. People are going to want to travel, to get back to work, to have deferred elective medical procedures. If so, the second half of 2021 could look more like 2019 than like the first half of 2020. If vaccines represent the light at the end of the tunnel, the virus means we are still in a dark part of the tunnel, despite seeing a light.
The Fed Speaks
A new economic outlook the Federal Reserve issued in mid-December predicted Real GDP will grow 4.2% in 2021 and 3.2% in 2022. While acknowledging the outlook was “subject to considerable uncertainty,” the Fed expects unemployment will decline from the 6.7% rate at the end of 2020 to 5% in 2021. Inflation is still projected to get back to 2% by 2023, with the majority of officials expecting the fed funds rate to remain near-zero until 2024 or later. Most Federal Open Market Committee officials also maintained their forecast of the rate being kept near zero at least through 2023. In addition, the committee said it will continue to support the economy through considerable monetary stimulus until it sees “substantial further progress” on its dual mandate of employment and inflation.
“The path to economic recovery will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term,” the committee said. Fed chair Jerome Powell emphasized that “there is more that we can do [with monetary policy, if needed. However,] in the near term, the help that people need is not from low interest rates. It’s really support.”
In other outlooks, survey results this month from the National Association of Business Economists (NABE) point to 3.4% annualized Real GDP growth nationally in 2021. The outlook was based on surveys NABE conducted with members in mid-November.
The University of Michigan’s latest outlook issued in late November forecasts real GDP expanding 4.2% for the U.S. in 2021, with economic growth returning to pre-pandemic levels in the second half of the year. Real GDP growth should taper off to 2.6% in 2022, according to University of Michigan economists.
What to Watch
There are a few areas of the economy to keep a close eye on in 2021. Two are labor market metrics: the rise in permanent job losses and long-term unemployment.
In terms of long-term unemployment, which is typically defined as longer than 27 weeks, the trend is not our friend. About one-third of the unemployed have now been without jobs for more than 27 weeks; even though the overall unemployment rate has come down from more than 14% in 2020 to less than 7% in January 2021. Long-term unemployment has historically resulted in two destructive forces: waning likelihood of finding a job and/or a higher propensity to exit the labor force. The good news on this front heading into 2021 is that the industries in the best shape—such as online retailing (and related shipping) and residential housing construction—are ramping up hiring and could begin to absorb more of the unemployed.
The COVID-based surge in the deficit and government debt is not necessarily inflationary. In fact, heading into 2021, the interest cost of national debt is near the lowest in several decades and set to descend before rising again. Even if interest rates doubled from here (not our expectation), financing our debt would not represent a significant strain—certainly not next year.
Although most global economies saw a relatively rapid economic rebound from the initial onset of the pandemic, the world still has not returned to normal. As 2020 approached its end, a major spike in COVID‑19 cases in the U.S. and Europe posed a renewed threat to the recovery. While the new vaccines and improved treatment therapies are encouraging signs for 2021, the economic effects of the pandemic are likely to echo for some time. Uneven progress could produce periods of market volatility.
The good news is the economy globally has the potential to make a full recovery next year, rebounding from the International Monetary Fund’s projected 4.4% GDP decline for 2020, with growth of 5.2% expected for 2021. If the IMF’s projection comes true for 2021, we would reach about .6 of a percent above where we ended 2019—a full recovery. A combination of easy monetary policy and fiscal policy combined with a successful vaccine rollout beginning in the first half should lead to a fairly strong rise in economic and earnings growth—especially in Europe, which is quite different from what we’ve seen in any outlook over the past decade or so. Under a scenario where virus cases continue to rise and the rollout of the vaccine does not accelerate, global growth could be reduced to less than a meager 2% this year.
However, Liz Ann Sonders, senior vice president and chief investment strategist at Charles Schwab, noted in December that, “given the still-beleaguered state of services and the lack of desire to utilize a lot of services—certainly in the travel, leisure, and hospitality area—I think that’s probably where we’ll see the bigger improvement from a pent-up demand perspective once we’re back in a more normal economic environment.” Sonders went on to say that what we have been seeing is “widespread optimism right now, suggesting that a lot of really good news is priced into the market already. This optimism poses a risk because outside of this positive consensus, it could trigger a bit of a contraction.”
Meanwhile, in Washington …
Having a Biden administration and Democratic Congress looks less like the result of a blue wave than a centrist tide, with moderate Democrats and Republicans holding the key to power in a 50/50 Senate. A tax increase looks more certain; but any tax hike is likely to be smaller than the potential spending increase and might not take effect until 2022. Also, there is bipartisan support for a stimulus package post-inauguration. The economy should get further aid from continued low interest rates and the COVID-19 vaccines that are now coming out and should become widely available in the spring. Achieving herd immunity from the coronavirus could trigger a release of pent-up demand in the second half of 2021.
Conclusion
We believe the pandemic and resulting vaccines are the key to the growth of the economy in 2021. We expect to see another dip in economic activity courtesy of the resurgent virus and implications of mandated, as well as self-imposed, lockdowns in first part of 2021. Assuming the new vaccines can be distributed on an accelerated scale, especially to higher‑risk populations, we believe economic conditions are likely to improve rapidly in the second half. With the change in administration and a Democratic Congress, we expect another stimulus program in the first part of 2021.
As noted above, some individuals will save the money, and some will spend it. Either way, the stimulus will help to maintain the savings rate above historical levels. The stimulus should also add to consumer spending, especially when the economy reopens and pent-up demand for leisure and entertainment activities can be safely pursued. However, until this point, we do expect the market to be volatile as unexpected negative news on the virus and vaccinations will happen. The other concern is the unemployment level; the level of the permanently unemployed must be watched as mentioned above.
A Note on the Assault on the Capitol
When Bowen Asset Management put out our blog item discussing what would occur in Washington, D.C., on January 6, 2021, we expected it would be political debate that prolonged the process into the early morning hours of January 7 before the inevitable certification of Joe Biden and Kamala Harris as president and vice president.
Like all Americans who believe in the principles of democracy and civility that guide our country, we had no expectations that what would cause the day to be such a long one would include the violent trashing of the Capitol in a deadly riot incited by some of those entrusted with guiding and protecting our nation. As patriotic Americans, we are heartbroken and appalled, and we strongly condemn what we saw on display. We also take this personally. A family member of an associate of Bowen Asset, a longtime staffer for a Republican senator, was put in harm’s way. We are happy to say she was lucky not to have been a direct victim of this storm of destructive violence.
Because the 18th century framers of our nation saw the dangers democracy could face, our legal and governmental institutions have continued to hold in the 21st century. Only time will tell if these violent impulses continue to hold sway with some our fellow citizens to the extent we saw on January 6. At Bowen Asset Management, we will continue to plan our work in the certainty that American democracy will prevail as it always has.
As always, if you have any questions about this report or any other questions, please reach out to Bowen Asset at info@bowenasset.com or (610) 793-1001.
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