Forward Momentum Continues

Global economic growth has moderated from its blistering mid-year pace, with a full recovery from the pandemic-induced lockdown recession not likely until well into next year. Failure to contain the virus has caused a slowing, but not stalling, of the expansion. Despite the more modest recent growth, the International Monetary Fund now predicts that the global economic damage caused by the pandemic this year will not be as severe as estimated earlier — a decline of 4.4% versus the 5.2% drop projected in June. As the economy continues to mend, in combination with historically low interest rates, we anticipate that stocks will continue to appreciate in the foreseeable future and build upon this year’s 4% gain for the S&P 500 through the end of September.

U.S. GDP plummeted at an annual rate of 31.4% in the second quarter of this year (interestingly, the actual change from the prior quarter was -9.5%). This was the first recession to severely impact the services economy and some geographic regions suffered to a much greater degree than others. For example, Hawaii and Nevada, with their heavy reliance on tourism, were both down 42% annualized, while the District of Columbia suffered a much milder 20% decline. Naturally, some segments of the economy will take longer to recover. Others, however, have already shown great improvement. The latest reading for the third quarter from the Federal Reserves’ GDPNow tracking model shows a record annualized growth rate of 35%. Thus, the initial recovery from the recession earlier this year appears to be V-shaped and the economy is entering the current quarter with good momentum.

The labor market continued to add jobs at a rapid pace in September. Although the recent employment report saw fewer jobs added than in prior months, the unemployment rate improved further than expected to 7.9% from 8.4% in August. A separate, more encompassing measure that counts discouraged workers and those working part-time for economic reasons also saw a considerable decline, dropping from 14.2% to 12.8%. Of the 22 million layoffs that took place during the recession, 12 million jobs have already been recovered since then. As the economy continues to improve, job growth should remain strong in the coming months.

Wages and salaries have also rebounded along with employment. The percentage gain for both is high-single-digits since April. Additionally, aggregate hours worked by all workers is up 12% from April through September. Consequently, with fewer opportunities to spend during the lockdown, personal savings soared and received an additional boost from the jump in government stimulus payments.

With more money in their pockets, consumer spending is now seeing a significant rebound. Following an annualized 33% drop during the second quarter, consumers are estimated to have spent 37% more annualized in the third quarter. Spending on goods is up 24% from the recession low to a new record high, while spending on services increased 16% since April but remains 7% below the peak reached in February. Importantly, consumers accounted for 24 percentage points of the freefall in GDP in the second quarter when lockdown restrictions negatively impacted their activity. They are likely to contribute more to the third quarter upswing.

Housing and autos, for example, are two areas that have benefitted from post-pandemic outlays. A housing-related spending boom is underway as a result of de-urbanization and record-low mortgage rates. Construction spending, along with that of furniture & furnishings and household appliances, is running at record-highs. The move from the cities to the suburbs and rural areas has also boosted the demand for autos. Spending on new vehicles is up by over 50% from earlier this year, while spending on used cars has almost doubled during the same timeframe.

Consumer sentiment index readings are still down relative to pre-virus levels, yet recent numbers are the strongest reported since Covid started spreading. Economists suggest that there is still enough fiscal stimulus in government social benefits and accumulated personal savings to boost consumer spending , possibly through year-end. Another round of stimulus may be stalled for now due to political posturing but seems likely in the next few months and would further benefit both consumer sentiment and spending.

The upcoming election likely remains the biggest near-term event for the stock market and the economy. It is still far enough away that any outcome is possible, but the market appears to be getting comfortable with the idea that a “blue wave” may even hand control of both the White House and Senate to the Democrats. This could mean $3 trillion more in taxes on both labor and capital combined with historically large spending directed towards climate initiatives and economic equality as well as another large pandemic stimulus package. The large amount of incremental spending could counter much of the negative economic consequences of tax hikes.

Reigning in the Covid virus and charting a path to normal economic activity will remain front and center for whoever gets elected. Therapeutics and vaccines appear to be making good progress towards finally ending the pandemic. Markets will begin to factor this in prior to coming to fruition, creating yet another reason to remain bullish on stocks.

Holger Berndt, CFA
Director of Research
hberndt@rssic.com