Notes on the Economy – 1Q 2021 Summary

VACCINES PROMISE FREEDOM

The U.S. economy slowed considerably in the fourth quarter of 2020. Real GDP (total output of goods and services) grew an annualized 4.0%—in normal, pre-COVID-19 times a high rate—versus 33.4% in the third quarter. The third quarter’s blowout growth followed the sharpest drop on record, 31.4%, in the second quarter. These precipitous shifts in growth trace a global pattern, largely dictated by government and individual responses to the COVID-19 pandemic. Efforts to contain the disease through social distancing and business closures were followed by easing of such measures, as infection rates waxed and waned.

Though less than perfectly executed, global monetary and fiscal policies have successfully prevented a freeze in the broad financial markets and a collapse in aggregate demand. In most countries, credit has been readily available and total incomes have been maintained, creating conditions for a sustained and robust global expansion.

There is reason for optimism that the world’s businesses and consumers will take advantage of such conditions during 2021. Crash programs to develop vaccines have been successful. Vaccination programs are now being rolled out and vaccine developers are ramping up production. Global infection rates are falling. New variants of COVID-19 pose some risk, but so far, current vaccines appear to be effective at preventing them from causing severe symptoms and hospitalizations.

HEADLINES – WHAT’S IMPORTANT

• Vaccines Promise Freedom – Timing is far from certain, but recent trends suggest the growing portion of the U.S. population with immunity—acquired naturally or by vaccination—will allow America to be substantially reopened for business before summer.
• Fiscal Policy Developments Are a Near-Term Plus – The fiscal spending boost now under consideration in Congress offers additional support for a post-COVID-19 economic revival.
• Bond Investors Still Face Low Returns – Higher yields only come with higher duration or higher credit risk. Bond yields will continue to creep upward as the prospects for economic growth improve.
• Cyclical Value Stocks Offer Some Protection – In the United States they are less exposed to the effects of higher bond yields and higher corporate taxes than growth and defensive stocks. Globally, they are relatively cheap and are the primary beneficiaries, via earnings growth, of economic recovery.

LOOKING AHEAD

The International Monetary Fund forecasts global real GDP growth of 5.5% in 2021, 4.3% for advanced economies and 6.3% for emerging and developing economies. If realized, 2021 will see the fastest global growth since 2010. However, the annual figures obscure uneven growth between countries and within the year. For example, real GDP in the Euro Area contracted 0.7% (not annualized) in the fourth quarter of 2020 and will most likely finish out a recession in the first quarter of 2021. However, rebounding activity is expected to put full-year real GDP growth for 2021 at 4.0%.

Cyclical recovery in the U.S. economy shows no signs of stalling out. Driven by fiscal policy stimulus, excess savings, and pent-up demand consumers went on a spending spree in January; retail sales were up 5.3%. The Institute for Supply Management’s January purchasing managers indices for both manufacturing and services posted a reading of 58.7, well into territory consistent with economic expansion.

U.S. growth should pick up going into the third quarter enabled by easing of COVID-19-related restrictions on mobility, additional fiscal stimulus, and readily available, inexpensive credit. Strong growth should continue for some time. Unemployment is elevated, and although lagging economic activity is concentrated in services that require close personal interaction, those are substantial—accounting for about 12.0% of normal economic output and one-quarter of the labor force.

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