The initial estimate of second quarter U.S. GDP showed that the economy reclaimed its pre-COVID peak and accelerated from the first quarter, although at a slower pace than expected. Real GDP grew at a 6.5% annualized rate, led by consumer spending on food and travel. The drag on growth came from a decline in inventories, homebuilding, government spending, and a wider trade deficit. Supply shortages, inventories, and buying conditions are likely to improve in the second half of the year as economic conditions normalize. Government spending may also get a boost from an infrastructure bill. These detractors could turn into contributors, which keeps the economy on track for 7% annual growth during 2021 even if consumer spending moderates.
On Thursday, the U.S. Commerce Department’s Bureau of Economic Analysis released its advance estimate of gross domestic product (GDP) growth for the second quarter of 2021. Real GDP increased at an annual rate of 6.5%, which was greater than the first quarter growth rate of 6.3%, but less than economists’ expectations of 8.4%. On a nice, positive note, this quarter marked the full economic recovery from the COVID recession; the GDP level at quarter end is above the pre-COVID level from the fourth quarter of 2019.
Advance estimates will be slightly revised, but let’s go ahead and dive into the report to see the contributors and detractors as well as clues for the second half of the year.
Consumer spending is the largest category of U.S. GDP at nearly 70%, and fortunately, consumer spending has been absolutely rolling. Personal consumption of goods and services contributed +7.78% of U.S. quarterly growth. That is the 4th best number in the history of the data. Consumption was great across the board, but services made a marked improvement from the first quarter as food services and travel accommodations recovered and contributed +2.24%.
The obvious risk that has been rippling through markets (more so bond markets than stock markets) is the Delta variant strain of COVID, once again constraining consumers and workers in the services sectors. After seeing significant spikes in cases in India and then the U.K., case counts in the U.S. are on the rise again after hitting extremely low levels in late May and June. If India and the U.K. are any indication, the current wave of Delta strain could peak and then decline rather quickly. The U.K. went ahead and lifted most COVID restrictions (“Freedom Day”) even during a massive spike in cases. Infections peaked two days later, and cases have since dropped sharply despite the easing restrictions. I should note that the U.K. does have a greater percentage of their population vaccinated than the U.S. (63.4% vs. 53.9%), but the latest spike is increasing the pace of U.S. vaccinations.
Fixed investments had a small positive contribution (+0.57%), led by equipment purchases, software, and research & development expenditures. Interestingly, residential real estate was a negative contributor (-0.49%). Housing starts plunged during the quarter amid concerns that the housing market has gotten overextended. Those declines may not last long given the exceptionally strong level of home prices and robust homebuilder margins reported so far for the second quarter.
The housing market deserves its own dedicated email, but as a primer, this week, the S&P Case-Shiller Home Price Indexes released May 2021 figures showing a consensus surge in prices. The national index was up 2.14% for the month and 16.61% over the trailing year. Since COVID hit the U.S. in February 2020, the home price composite indexes are up 18-19%, while most large cities are up between 14% and 21%. Of the major metropolitan areas, Chicago and New York have been the laggards at +14% and +15%, respectively, while the leaders have been San Diego, Seattle, and Phoenix at +28%, +29%, and +30%.
Inventories (-1.13%), trade (-0.44%), and government expenditures (-0.27%) were all negative contributors to GDP in the second quarter. Shrinking retail inventories due to the ramp-up in consumption and supply shortages are more of a technical lag. Those will eventually turn around when supply catches up to demand. The same imbalances due to the pandemic recovery have also negatively impacted net trading.
Government consumption as a detractor is surprising on its face. However, transfer payments such as economic impact payments and federal unemployment benefits are not considered. The decrease in federal government spending primarily reflected a decrease in nondefense spending on intermediate goods and services. In the second quarter, nondefense services decreased as the processing and administration of Paycheck Protection Program (PPP) loan applications by banks on behalf of the federal government declined.
Government spending may soon turn into a contributor to economic output. On Wednesday, the Senate found some consensus on an infrastructure bill and passed a procedural vote with 17 Republicans joining all 50 Democrats. It is not a done deal, but the bipartisan package cleared a couple of hurdles this week. The proposal includes $550 billion of new spending in addition to approximately $450 billion of legacy infrastructure spending.
Nearly half of the total new spending goes towards roads & bridges, power transmission, and railroads (mostly passenger but also freight). Other major initiatives include upgrades to high-speed internet access, investments in clean drinking water, upgrades to airports and commercial ports, and transit. Altogether, it is a large bill, but falls far short of initial Democratic infrastructure spending and priorities. There are alternative plans for a $3.5 trillion dollar bill with a greater emphasis on climate change and social initiatives to be shuttled through the budget reconciliation process. However, Democratic Senators Joe Manchin and Kristen Sinema have both publicly opposed the size of the alternative bill.
In addition to addressing needs, the $1 trillion bipartisan infrastructure bill would provide fiscal support. After passing the $2.2 trillion CARES Act, $900 billion appropriations bill, and $1.9 trillion American Rescue Plan Act in the span of one year, the economy is effectively experiencing fiscal tightening.
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist