Notes on the Economy – 3Q 2021 Summary

New COVID-19 Variants Pose a Risk to an Otherwise Sanguine Outlook

The global economy is experiencing a strong revival. World-wide output was depressed in 2020 as a result of the COVID-19 pandemic. Global real GDP fell 3.2% year-over-year, with nearly all national economies in contraction. In 2021 vaccinations, easing restrictions on economic activities, and expansive fiscal and monetary policies are supporting a rapid rebound. Nearly all national economies are on the mend. However, advanced economies are recovering faster than emerging market and developing economies, largely because of more readily available access to vaccines.

Among advanced economies the United States is showing one of the faster rebounds. Consumer spending and business capital spending have been particularly strong, supporting annualized real GDP growth of 6.3% in the first quarter and 6.5% in the second. Growth of real final sales was actually stronger, 9.1% and 7.7%, respectively. A steep drawdown of inventories has been required because production could not keep pace with expanding domestic demand.
Annual inflation has recently exceeded 5.0%. Federal Reserve (Fed) policymakers maintain (probably correctly) that is a result of COVID-19-induced base effects and supply chain disruptions that will prove transitory. So, it is in no hurry to tighten its exceptionally easy monetary policy.

HEADLINES – WHAT’S IMPORTANT

• Emerging COVID-19 Variants Are a Wild Card – Vaccine development has been a success, but its global roll-out has been slow. Further, the initial virus has been crowded out by the evolution of more contagious variants (Beta, Delta, Gamma) against which current vaccines offer lesser protection.
• Inflation Concerns Continue to Mount – Data supports the contention that the recent inflation spurt is temporary, but the risk of a longer-lasting surge in the price level initiated by an overly expansive fiscal policy is elevated.
• Bond Investments Are Far from Risk-Free – The economic expansion may justify the current low credit spreads on corporate, state, and local bonds, but it will eventually lead to higher yields and material declines in longer-term bond prices.
• Corporate Profits Exhibit High Growth – The global recovery is driving exceptional corporate profit growth, particularly in the United States and Europe. Prudent investors should position portfolios for relative gains in U.S. small- and mid-cap, foreign, and value stocks.

LOOKING AHEAD

Currently U.S. real GDP for 2021 is on track to advance by 6.0%. If emerging variants of the COVID-19 virus are successfully confined to relatively small segments of the population through vaccination and masking protocols (and thus avoiding economic shutdowns), U.S. real GDP should experience high growth from mid-2021 through mid-2022.

Various indicators lend credence to the prognosis. For instance, the Institute for Supply Management’s purchasing managers indices (PMIs) for both manufacturing and services have been in expansion territory throughout the first seven months of the year, while new orders for capital goods have marched upward, and employment has continued to advance. Consumers have built a pile of savings and are in good shape to support continued spending growth. Corporate profits are strong and capable of sustaining high growth of capital spending. The Fed’s easy-money policy will keep interest rates and financing costs low for businesses and consumers alike.

On balance, the outlook for the world’s economy is positive. However, new COVID-19 variants and ongoing disruption of global supply chains are impeding the recoveries now underway and widening the divergence in economic trajectories. The extent of a country’s dependence on tourism and reliance on exports are now major factors in determining how rapidly it may be expected to return to a semblance of pre-COVID-19 normalcy. Notably, the pace of improvement in emerging and developing economies has slowed recently. Still, presuming setbacks remain largely localized, the International Monetary Fund’s projections for global growth—6.0% in 2021 and 4.9% in 2022—may be in the ballpark.

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