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!