February 1, 2021 – Last week on Thursday we got a new snapshot on how the economy is doing. The Bureau of Economic Analysis released the quarterly Gross Domestic Product (GDP) numbers that day and the headline number came out as +4%. So the economy grew at an annualized rate of 4% that quarter or about 1% quarter-over-quarter. Not bad! Considering the uncertainty about growth going forward after the blockbuster 33.4% third quarter growth number it’s reassuring that we kept some of the upward momentum in the fourth quarter.
But just to be sure, there is still a lot of economic pain and uncertainty out there. You ask two different people and you will hear two different opinions on how the economy is going. Unless, of course, they are economists and you will hear three different opinions, as the joke goes.
Since I wrote my post about the Q3 GDP release three months ago and it was quite popular, I thought it would be a good idea to write another update. Is the recession finally over? How much of the pandemic-induced loss has the economy recovered? Do we have to worry about a renewed drop in the economy? Let’s take a look..
Is the recession over?
People asked me whether the two consecutive quarters of positive growth imply that the recession is over? First of all, the “two quarters in a row” metric is used neither in pinpointing the recession nor the expansion starting point. The 2001 recession never had two consecutive negative quarterly growth rates. And during the 1970 recession, we observed two quarters of positive growth in 1970Q2 and Q3, even putting the 1970Q3 GDP above the previous expansion peak. But 1970Q4 saw a big drop again, so the NBER business cycle dating committee put the recession trough in Q4 of 1970.
So, we all have to appreciate the tough job that the NBER faces in pinpointing the end of the recession. As I have written previously in the context of both recession/expansion-timing and bull/bear-market timing, we’re now in the limbo state where a continued recovery would trigger an announcement of a recession trough likely in April 2020 and the start of the expansion will then be “backdated” to May 2020. But a potential renewed weakness in economic activity will likely be called a continuation of the recession that started in March 2020.
By the way, it took the NBER until 2003 to finally announce the end of the 2001 recession, but I hope they will decide this one faster! 🙂
Also, even if the new expansion really started in May 2020, we’re not completely out of the woods yet. There is one nasty precedent in the early 80s, where the end of the 1980 recession was called, a new expansion started but it lasted for only two quarters before another recession hit. And that was a nasty and long recession!
So, two consecutive quarters of positive growth, as much of an achievement that may be, doesn’t sound so comforting. And if the economy were to keel over again in 2021, it’s really mostly semantics about whether we call this a new recession or one long event.
So, what are the odds of renewed weakness? I looked at some of the standard business cycle indicators – Industrial Production, Payroll Employment, Real personal income (excluding current transfer receipts), and Real Wholesale Trade since Feb 2020 – and they have shown an impressive recovery starting in May.
While Industrial Production continues its strong upward trend, the other series started to sputter a bit again. They are not falling much, certainly not bad enough to signal a recession, but they certainly look pretty shaky to me. Income is down slightly for two months in a row and payroll employment also fell slightly in December. The new employment data will come out on Friday, and that release will be watched carefully!
One important indicator I always like to monitor will come out just a few hours after I schedule the publication of this post but a few hours before I normally get up on a Monday morning: The Institute for Supply Management (ISM) Manufacturing Index. As of December 2020, it certainly looked very strong (consistent with the strong Ind. Production trend). I will update the chart on Monday morning. Because the ISM index is one of the more reliable leading indicators, I’m not too worried about a recession right now with the data we have available. Very likely we’ll muddle through with 2 to 5% annualized growth rates for the next few quarters and then about 2% long-term.
Update 2/1/2021: The index dropped slightly from 60.5 to 58.7 in January. Still very solid!
The growth vs. level dichotomy
The dispersion of economic sentiment, in my view, largely boils down to the distinction between levels and growth rates. The level of GDP is certainly still below the Q4 2019 peak, but the expansion starts when growth turns positive again. We don’t have to wait until we reach the new peak. The following medical analogy comes to mind: the recovery of a patient starts when he/she no longer gets worse. Maybe after emergency surgery. The patient might still be in the hospital, might still be in pain, might still be on medication for many days and weeks to come. So, the starting point of the recovery is much earlier than the time when we declare the patient made a full recovery. Same idea with the economy!
I will also reiterate my point from the post last quarter: Just getting back to the old peak means only zero growth over an extended period. If you had applied a rough trend growth rate of 2% to the old peak, we’re still 4.5% below that trendline. Not quite as bad as the multi-year 7% drop below the trend during the Global Financial Crisis, but it’s certainly painful!
The recovery is very uneven!
Another reason you encounter a wide variety of opinions on how the economy is doing: The GDP number is the broadest aggregate economic measure available. Not more, not less. If the economy is still 2.5% below the all-time-high it does not imply that the entire economy, all corporations, all mom-and-pop shops, all workers, and all investors are uniformly 2.5% underwater. It could mean that 90% of the economy is back at a new peak and 10% is still 25% below normal. Or 97.5% is back to normal and 2.5% of the economy we knew in late 2019 is at -100%, poof, completely gone forever. Or any combination. It could also mean that portions of the economy are already significantly above their 2019 peak and some pockets are all the more underwater. Our personal financial situation is better than before the pandemic, while others are still hurting financially.
How much dispersion is there in GDP? If we look at the disaggregated data in Table 1.5.6 on the BEA website we can calculate both the year-over-year growth rate as well as how much each of the underlying categories and sub-categories would have contributed to the roughly -2.5% overall GDP growth rate. As I suspected, the growth rates vary wildly. Some of the service categories, especially transportation, recreation, and food services, are still significantly below their 2019Q4 level, by 20 to over 30%! A depression-size impact! Not surprisingly, expenses for gasoline (due to less travel), and investments in structures and transportation equipment also got hammered. But some other categories shine: consumers flush with stimulus cash and a lot of time on their hands, went on a shopping spree for durable goods and new housing construction (=residential investment)! Business investment in equipment outside of transportation was also very strong.
Also noticeable is that the government expenditures were slightly down overall, with the federal government consuming about 2.5% more but the state and local consumption down by about that margin. Isn’t that at odds with the government spending like drunken sailors recently? Not at all. Transfer payments like unemployment benefits and stimulus checks would not be counted in the “Government Consumption” category in this specific GDP calculation, because the government wasn’t the final consumer. Otherwise, you’d double count when you include the transfer payment in government consumption and then again when John Q. Public spends the money at GameStop.
So, the punchline here: depending on your sector and your niche in the economy, your business could be rocking and rolling or you could face a depression-like economic environment.
Conclusion
There you have it. I think with the new GDP release we achieved another positive milestone. But we’re not out of the woods yet, so stay tuned! It’s an exciting time to be an economist!
Wow! If only there were more economists who made the effort you do to clearly explicate the situation, as the statistics describe it, economics might not have the dismal label. I haven’t plumbed the stats to this depth since the 2010 era, but you’ve inspired me to look deeper again. Perhaps you’ve already done it–did you ever do any analysis of the effect of the corporate tax cut on investment in 2018, or subsequent years?
Thanks!
There was a jump in growth after the 2018 tax cut. Going from 2% to 3%. Which was a big move back then, but it’s hard to assign that to any one policy.
Might be useful to add a column with total spend for each category in the series YoY % change to give us an idea of overall impact/weight.
Also, for your personal benefit (to drive more traffic to your site), my rss reader shows full story as opposed to just the start (teaser) and a link to the site for the rest (which other bloggers do). (I like to reward my providers of great information. )
Thanks. Good suggestion.
To not clutter the table even more I will leave it as is and give the following “hack” to people who wonder about the shares in GDP of the different components: If you want to gauge the weight of the components in overall GDP, take the ratio of the two columns. For example: “Gross private domestic investment”: 0.57%/3.21%=0.18. Then this component has a share of 18% in GDP.
For some of the exotic components with the really large Y/Y growth but a small contribution you can tell that they must have a really small weight! 🙂
About the RSS feed: that’s strange. I publish the article so that in the email announcement there is a break point and you have to click to read the entire article. Not sure how to ensure this in the RSS readers, though. If anyone has an idea, please let me know!
Dug into the BEA archives a little to get back further than 2018. I’ll try to make do with words since I can’t paste the graph. We’ll consider net non-residential investment rather than gross, because the ~$2T/Y in depreciation included in gross is essentially a background that the signal we’re interested in is riding on top of.
Net nonresidential investment (Row 20 A593RX in Table 5.2.6U) was flat for 3 quarters from Q117 through Q317 at ~$470B/Y (chained 2012$), then it jumped by 8% Q/Q to $508B/Y in Q417 (before the corporate tax cut), and by another 11% Q/Q to $565B/Y in Q118 (after the corporate tax cut), before rolling off and climbing more gradually another 6% Y/Y to $601B/Y in Q119, before declining gradually by about 3% per quarter to $547B/Y in Q419. If we take the pre-tax-cut Q417 level ($508B/Y) as the baseline (ignoring that the Q3-Q4 trend was sharply upward), then non-residential net investment rose by $70B/Y to an average of $578B/Y (+14%) during the two years following the corporate tax cut–only about 35% of the ~$200B/Y increase in stock buybacks to $800B (https://www.cnbc.com/2018/12/18/stock-buybacks-hit-a-record-1point1-trillion-and-the-years-not-over.html) that occurred in 2018. Please tell me if I’m wrong, but it looks to me that, as a country, we spent almost 40% more on stock buybacks in 2018 than we did on net nonresidential investment. I’m thinking both Mr. Smiths (Adam and the one Jimmy Stewart played) would be spinning in their graves.
Corporations can do with their money whatever they see fit. Stock buybacks are more tax efficient than dividends. The share buybacks ended up in my stock portfolio and corporations do what I want them to do: make money for me and my family.
Also, I can’t really follow you calculations very well. What matters for investment spending is the gross not the net investment. That went up substantially in 2018 and 2019.
Also, pinning your entire analysis to one single quarter is dubious. Maybe the investments already climbed that quarter in anticipation of the tax cuts?
But again, even if your entire analysis is correct and none of the tax cut is spent on tangible capital investments, then so be it. Adam Smith is still resting in peace. 🙂
,The email doesn’t show the entire article and I have to click the “continue reading” to jump to your website. So it is working as you intended for email subscribers.
That’s good to hear! Thanks for confirming! 🙂
Regarding the graph of the two recessions relative to a 2% trend: One of the main rationales for the size of the $1.9T stimulus/relief package is that the 2009 stimulus package was too small. However, that was a financial crisis, and recoveries from financial crises usually take longer (and have further to climb) than normal recessions (Reinhart & Rogoff). When you look at the curve for the 2020 recession, does it make you concerned that a $1.9T stimulus might actually lead to inflation this time? Maybe they’re fighting the last war, or is 10% of GDP not enough of a perturbation to provoke a significant inflationary reaction?
Good qustion! The recent experience in the developed world has been that that government debt can actually be deflationary (Japan, EU). That’s the only thing even worse than inflation and we face the same risk here.
We are basically one more relatively sooner than later profit taking correction and moving forward.
Afterall “the system was not broken i the first place” and unlike all previous times (yes all) govt is focusing on making sure that the most lowest social economic status people get the most most (which is good) because they have the highest propensity to spend. Most of the previous times government was royally stupid by basically pulling back in fiscal issues causing tons of cascading problems.
I am making a point that all previous times “economic systems were broken”. This time around there was a just a huge push on the break paddles but the car didn’t get into accident just wheels got worn out. The car is still good – and can go 200km on autobahn again. -:)
I think, you were indirectly or subconsciously trying to do your social responsibility by taming expections. Which is good – this will cause us to have plenty of dry powder ready for deployment when right time comes.
And the wheels are going round-and-round
That’s a good way of putting it. I hope you’re right that the people who need it most get the $$$. I have my doubts though because for people in real need $600 or $1,200 or $1,400 isn’t that much. 🙂
Yes. You are right. I was little stronger in my statement than necessary.
Early in this we wondered what type of letter we would end up. V? L? We know now it’s a K. For those of us lucky enough to be in the right industry, things are good financially. What now? Our government is doing the right thing by continuing to help those not so fortunate (insurance company with an army after all). The key now as it as been is how quickly we beat back the virus.
Americans just aren’t good at lockdowns or doing collectively what is good for us all (because we can’t always agree on what that is, unless is is extremely obvious to all). We aren’t going to slow the spread like Australia has, where recently one case in Perth recently spurred a total lockdown, which was mostly welcomed. So it’s a race to vaccinate before the next wave. While I’m hopeful we will eventually get there, I’m watching what has not happened to this point and thinking we will end up doing this slower than we should have, and we have one or two more waves in front of us. That translates to an L shaped economy in general where the government continues to step in when things slow during a wave, and then things take off late this year.
Sadly, the governemnt gives out handouts that are too small for people in real need. While the people with a job (and FIRE people) get an undeserved windfall.
A total lockdown is crazy. I’m a fan of the Sweden-model on this one.
My hope is that the current wave in the US is currently abating and with more vaccinations we will not have sizable new waves. Cross my fingers!
There’s just no evidence-based argument that taking a strong health response to control the virus hurts the economy. Rather, we’ve seen the opposite. Just compare New Zealand’s economic performance to Sweden’s…
Q2 in NZ had a -11% fall, but a 14% recover in Q3. Q4 figures aren’t out yet, but there going to be very strong. Unemployment peaked at 5.3% and is now down to 4.9%, only up about 1% from pre-COVID (3.9%). The employment rate is nearly identical to what it was pre-COVID (67%).
Q2 in Sweden had a -8% fall, and only a 4.9% recovery in Q3. Q4 was stagnant with 0.5% growth. In terms of unemployment, Sweden started at 7%, peaked at 9.2%, and is only back down to 8.6%. Sweden’s employment rate is still down 1% on what it was pre-COVID (68%).
Meanwhile life was totally normal in NZ throughout 2020, with no excess deaths. Perth’s preemptive short lockdown was the right approach.
NZ is a large, sparsely populated country, smaller than 9 U.S. cities/metro areas. It’s an island nation, and inflows of people can be easily controlled. So, please, we can’t really compare.
Vietnam, Taiwan, South Korea… Only one is an island. Two are very internationally connected. Two are democracies. None can be described as sparely populated. They range in income from poor to developed.
What unites them all is that they decided to control the virus and have had very good economic performances, all things considered.
Aggressive suppression and even elimination is possible even in densely populated countries with land borders.
You can’t compare what you’re blind to.
South Korea is a de facto island (or how much cross-border traffic is going through the DMZ on an average day???). Taiwan is an island. Both countries have a long history of mask-wearing (apparently going back to SARS and even before) and Taiwan in particular had the advantage of a hostile relationship with mainland China (not much pushback against an “evil xenophobic” travel ban) and a headstart with almost zero cases that were all followed up diligently and prevented the exponential growth taking off like in most countries. Probably SK did something along the same lines.
Granted, I’m very impressed with both Taiwan and SK. I doubt that their strategies could have been implemented in the US, though.
I can’t comment on Vietnam. Don’t know enough about their response. Tanzania had only 509 cases in a population of 60m. Last time I checked that’s better than even NZ. And Tanzania did even less than the US in terms of shutdowns. Should we all follow the example of Tanzania now? Careful with cherry-picking, because I can play that game, too!
Some European countries shut down extremely aggressively (Poland and Czech) and prevented an early outbreak. Only to be steamrolled by second and third waves.
And don’t get me started on the idiocy of comparing data across countries when different countries have different standards on what thy consider confirmed cases/deaths.
But I got carried away. Since the article is a GDP update, I like to shut down this dreaded pandemic policy discussion, which is a side issue of a side issue. If you want to vent on the pandemic issue, please look for a different outlet.
Typical economist, explaining things after the fact. That honestly helps nobody.
I encourage you to write thoughtful forecasts if you want to build a good reputation and help readers make money.
I published a forecast on April 8, 2020 for how I think the pandemic will work out. It was pretty accurate: I completely nailed the big drop in Q2 and the recovery in Q3. The forest for Q4 was that we will still be 3% under the pervious peak, while the true number was 2.5%. Pretty good for 3 quarters ahead. If you can show me another forecaster that gave you a forecast this accurate, please let me know!
https://earlyretirementnow.com/2020/04/08/financial-lessons-from-the-first-quarter-2020/
Interesting – based on how much poverty I see in my own country I think the Covid lockdowns hit developing markets a lot harder than developed markets. I suspect that a large part of that is due to receiving little to no financial assistance from the state but still being forced to lockdown and close businesses. Poor folks went from some income to zero in the space of weeks since March 2020.
I’m interested to see how it plays out in the US, will government assistance to businesses end before the virus is under control? If there’s a timing mismatch then there will be real issues, versus if the government funded what is a temporary reduction in earnings by printing money. If short term enough the US may get off lightly (relative to other markets) on the economic front.
Very true. This disaster and many others will always hit the poor the worst. And that’s true across countries and also within countries. It’s different from the global financial crisis that was probably more of an equal burden, maybe even heavier burden on richer Americans (in % loss of income/wealth).
We will see how this works out
https://www.nytimes.com/interactive/2021/02/08/opinion/stimulus-checks-economy.html?smid=url-share
This is a very interesting look at the utility of stimulus checks in promoting economic activity, comparing how much of the original (April 2020) $1200/person stimulus was actually spent vs. the more recent $600/person (Jan 2021) checks, as a function of income level. In April, all income levels were feeling the pinch, so the spending was almost independent of income. By the end of 2020, employment among higher income people was back to pre-pandemic levels, but their spending had remained suppressed, so when they got their $600 checks, they banked most of it. However, among the lower income levels, employment is still 20% lower than pre-pandemic, while spending has recovered–items like food and rent are a higher proportion of spending among lower income households, and, for the most part, can’t be postponed, so when they got their $600 checks in January, they spent them quickly. That’s more effective from the perspective of creating economic activity. The authors suggest that this difference, based on the January spending data, should be considered before sending out the another round of checks.
Interesting analysis. Thanks for the link!
I should also stress that by simply sending out checks and piling on more debt, the government cannot create aggregate income. It’s robbing Peter to pay Paul. You can never increase aggregate activity that way, see Japan’s feeble attempt at stimulating over the last 30+ years. I would only endorse the transfers to cushion the pain of those 10-20% worst impacted. It should never be a broad-based program.
That’s pretty interesting, I had no idea there was a historical period where there was a recession and two quarters of expansion before heading into a recession again. With all the quantitative easing that’s going on, I don’t believe that the U.S. will experience another recession in the next quarter.
However, I have been known to be wrong a lot so who knows.
I hope we’re both right! 😉
But then again: the quantitative easing is great at avoiding a meltdown in the middle of the recession. But not so much at keeping the expansion going. It’s like pushing on a string.
But I certainly hope the expansion will now walk on its own…
Hi Ern,
What is your opinion on currently steepening yield curve? And do you support idea that inversion is just a sign and it’s the steepening that kills economy?
Cheers
A steep yield curve is a good sign. Long-term expectations are for higher interest rates but the short-term rates are still low and stimulative. I’m happy with the current situation. Even though it’s killing my bond portfolio used to hold the margin cas in my options trading portfolio 😉