The U.S. economy reported a record-breaking turnaround in the third quarter by growing 33.1% annualized (7.4% actual). Even with the astonishing rebound in the third quarter, the economy still has ground to make up to return to pre-coronavirus levels. The recovery speed will depend in part on the size of fiscal stimulus expected after the election, and an even bigger factor will be the path of the coronavirus – mitigation and treatment. Uncertainty over COVID-19 had a negative impact on stock markets this week and continues to impede upon business reopening and investment plans.
There were more tricks than treats this past week, but I will start on a positive note. The Bureau of Economic Analysis reported that the U.S. economy grew 33.1% annualized during the third quarter, which topped economists’ steadily growing expectations of 32%. The economic recovery was in full swing after the coronavirus pandemic caused declines of 5% during the first quarter and 31.4% during the second quarter. The reporting is a bit strange when it comes to gross domestic product (GDP) growth. These figures are quarter by quarter changes, but seasonally adjusted and annualized. In actual terms, economic output had a peak to trough drop of 10.1% during the first half of the year, and now as of September 30th, U.S. real GDP has recovered two-thirds of that loss to stand 3.5% below its level at the beginning of the year.
Last quarter’s recovery was led by a boom in consumer spending and housing. We touched on it in last week’s Strategic Insight, but there has been a marked shift in personal consumption from services to goods. The trend had previously been towards spending on “experiences” rather than “things”, but the coronavirus and social distancing guidelines has compelled consumers to reverse course.
During the third quarter, consumer spending surged by 40.7% annualized, as shelter-in-place eased and fiscal support unleashed a wave of pent-up demand. Durable goods spending rose a remarkable 82.2% annualized to reach 11.9% above beginning-of-year levels. Household furnishings, autos, and recreational goods led the way. Nondurable goods spending also rose sharply, +28.8% annualized, led by clothing and gas demand. Despite a 38.4% annualized increase, spending on services is still 7.7% below beginning-of-year levels. The lagging areas include recreation, food services, hotels, and transportation, which remain 20%-35% below pre-coronavirus levels.
Outside of personal consumption, housing more than recovered by growing 59.3% annualized; business investment rose by 20.3% annualized; but government spending fell 4.5% annualized, as non-defense federal spending pulled back 18.1% and state and local governments pulled back 3.3%.
Looking ahead, there are obvious risks to maintaining the economic recovery. Another round of fiscal stimulus failed to pass before the election, which may delay it all the way until February. There is also a decelerating jobs market recovery, and the threat of reopening/closings due to the third wave of coronavirus cases.
After bottoming in mid-September, U.S. coronavirus cases have been firmly increasing over the course of the last six weeks to new peaks. The latest wave of infection hot spots is spread across the central U.S. Midwest and Big Sky states as colder weather arrives. And it’s not just the U.S…. Europe is struggling with another wave of the virus, and countries like France and Belgium are imposing an additional round of shutdowns.
The U.S. positive test rate percentage is rising slower than infections, which suggests that an increase in testing capabilities may explain many new infections. Based on these metrics, JPMorgan estimates that slightly more than 60% of case increases since Labor Day can be attributed to increased testing. Meanwhile, in most of Europe, testing only appears to explain a small part of the spike. The increase in infections in Western Europe has surpassed spring levels, and hospitalization and mortality levels are starting to rise as well.
Fortunately, U.S. mortality levels have remained relatively stable and mortality rates have improved, especially when compared to the first outbreak in March and April. This progress can be ascribed to demographics (i.e. a younger average age of infected people), less overcrowding in hospitals, and more informed standards of patient care.
If mortality levels and rates remain at their current points, there will be less appetite, especially in the U.S., to reimpose shelter-in-place measures seen during the early stages of the pandemic. Targeted and localized closures are possible if virus trends were to deteriorate. But keep in mind that consumer spending categories most affected by COVID-19 (recreation, food services, hotels, transportation, and other services) only make up 12.6% of U.S. GDP, and industries most affected by COVID-19 (airlines, hotels, restaurants, and leisure) only make up 4.8% of the S&P 500 index.
Mostly positive economic data and earnings season results (79% of companies’ earnings have beat estimates) were not enough to overcome investors’ concerns and prevent a selloff this past week. Besides next Tuesday’s election, investors were weighing rising coronavirus cases noted above and the final nail in the coffin for stimulus hopes before Election Day.
The major stock indexes lost ground on four out of five trading days last week including a sharp decline on Wednesday. It was the stock market’s worst performance week since the week ending March 20th during the depths of the coronavirus downturn.
All eleven of the major S&P 500 sectors fell on the week. Technology and consumer discretionary sectors, which have easily been the best performing sectors year-to-date, declined 6.5% due to earnings releases and maybe some profit-taking. The economically sensitive industrials and energy sectors also declined by 5%+, while the defensively-natured utilities sector outperformed with only a 3.6% drop.
Developed international stocks performed in line with their U.S. counterparts due to their own COVID-19 issues, but emerging markets declined less than 3% on the week. Since the stock market high water mark on September 2nd, emerging markets (MSCI EM Index) have returned -1.4% compared to -7.1% for the S&P 500 Index, -6.2% for the MSCI All Country World Index, and -10.0% for the NASDAQ 100 Index.
Let’s look forward to moving past a scary Halloween week and capping a contentious election season next week.
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist