Pollack: Record GDP contraction

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& Company
August 3, 2020

The Monday Morning Quarterback
A quick analysis of important economic data released over the last week

The most widely followed economic headline of last week was not the most important. We’ll cover the headline news first and then get to what was really significant. The headline was about real GDP contracting at a record rate of 32.9% (annual rate) in the second quarter. This was actually a little less than the general expectation. The record decline was expected because so much of the economy was shut down in April and May only to re-open around mid-May and then shut down again shortly after reopening.

Other big news includes how the reclosing of places that create crowds will affect the third quarter. The July setbacks for the jobs market (July employment data comes out Friday of this week) will set the tone for the rest of the quarter and perhaps the rest of the year. Given the number of businesses that had to go dark again (see the number of people receiving unemployment benefits last week), the odds of any near-term significant rebound has become a lower probability event. This is true despite the high personal savings rate.

The recovery, when it does come, will take longer and be slower (remember the Nike Swoosh shaped recovery curve). It’s also clear that COVID-19 will dictate the terms of the recovery. The pattern is now clear. When the virus seems to be under control, people become less likely to follow the basic rules. (Stay at home if you can. Stay away from crowds. Mask up. Physical distance. Wash your hands frequently). So, the virus makes a comeback. Then, things close up again. This has been the pattern in the various states within the U.S. and is also becoming the pattern in most countries across the world.

This disease will not go away unless human nature changes and people take it more seriously. The result is that any major reopening of the economy will likely have to be slow and is also likely to have a stop-and-go pattern until we get both a vaccine and therapeutics that create a much safer environment. This will be true as long as “new cases” are a major measure of success. While some believe that deaths, hospital capacity usage and age of those infected are a better measure than simply cases, they apparently don’t run the show. In addition, looking at life-years of COVID-19 patients saved for vs. life-years of regular patients lost suggests that new protocols are needed for regular patient care. The bottom line is that the 2nd quarter GDP numbers really don’t matter.

Personal consumption fell almost 35% and private fixed investment fell 49%. Yet, the good news is that discretionary income jumped more than 40% (thank you CARES Act) and the savings rate shot up to 25%. Many Americans are in great shape financially. But, there are also many who are not. This is due to the inability of the political process to so far create a follow up to the CARES Act. That was the real news of last week. The utter lack of concern for the average American on the part of the political process in an election year (or any year for that matter), sickens me. This is not the time for pork (Can you say “bail out for states and municipalities that behaved badly and showed little fiscal responsibility”.

They would be rescued by taxpayers in those states that behaved well in terms of spending and funding of pension plans) I mention that one as one of the most egregious. But, there’s plenty of pork in both the proposed HEROES Act (proposed by Democrats) and the proposed HEALS Act (the Republican version). It’s not the time to fund anything else but what is needed by those who are out of work due to actions not of their own making. It’s also important that the perverse incentives created by paying people more for sitting on the couch than working are eliminated. For a full explanation of why those who are unemployed due to COVID need to be provided for, go back to the March MMQs.

But, basically, those who remained employed during the pandemic will come out of this with lots of cash that they have saved because of so much normal spending that couldn’t take place (vacations, going to Cousin Izzy’s wedding, shopping, eating at restaurants, going to a football game, meeting friends at a bar, going to a concert or a movie or a museum, etc). On the other hand, far too many of those who lost their ability to earn an income could come out of this with large debts and an inability to get back in the economic game at any time soon. This would create such significant problems for the economy as a whole that would take years to fully recover. This cannot be allowed to happen. The pork is something for a later date. 

As for last week’s data, real GDP was, as mentioned above, down at a record rate. Initial claims for unemployment insurance were up and continued claims were up a lot. Personal income was down from a month ago but was up a lot from a year ago. Both major measures of consumer confidence fell in July. Manufacturers’ new orders were up for the month. Fed policy continues to be accommodative. And the pending home sales index was up a lot. In Arizona, initial claims declined but were still way up from a year ago. Sky Harbor traffic was up from a month ago but way down from a year ago. And housing prices in Greater Phoenix were way up reflecting the large supply/demand imbalance in the area. 

As for weekly data, national hotel occupancy rose modestly for the week ending July 25th to 48.1% This compares to 47.5% the previous week. It is still down 38.3% from last year. TSA traveler throughput was off slightly on a national basis. This was the second consecutive weekly drop. The 4,622,736 flyers represents a 74.5% drop from a year ago. Seated diner activity in the state was down 62.2% from a year ago. This compares to a decline of 66.3% the previous week. The Google Mobility to Work Index for the state was down 35.4% from a year ago compared to a decline of 36.1% the previous week. And the Mobility Index to retail and recreation places were down 25.0% from a year ago in the state. 

U.S. Snapshot:

  • Real GDP declined 32.9% at an annualized rate in the second quarter of 2020.  Weakness was spread across segments.  Consumer spending, most investment components, exports and inventories contributed to the decline while government spending and imports were slight offsets.  Real disposable income surged 44.9% thanks to federal stimulus after rising 2.6% in the first quarter.  The savings rate soared to 24.2% high in May (19% in June) from 7.1%.  The recession, while the shortest in history, was the most severe.  This was due to the man-made nature of the situation and the government response to it.  Also, according to Yelp, 72,842 businesses listed on the site on March 1 have closed for good.  Not a positive for the employment prospects of workers who thought they were furloughed and would be back to work soon.
  • Initial claims for unemployment insurance increased modestly the week of July 25th, to 1,434,000 from 1,422,000 the previous week.  The number is 563.9% above the year earlier level.  The 54.1 million who have applied since mid-March represent 35.8% of March employment.  Continued claims rose to 17.0 million the week of July 18th (latest data available).  That was up from 16.2 million the previous week.  This increase suggests that the effects of the layoffs due to the re-closure of parts of the economy in July caused significant employment issues. 
  • Incomes fell in June as government support slipped further.  The 1.1% decline was due almost entirely to the 8.9% drop in government transfers.  The original federal government response to the pandemic was swift.  But, it will have been for naught if congress fails to pass another round of stimulus quickly enough to keep the economy from slipping back into recession.
  • Both major measures of consumer confidence slipped in July as COVID-19 cases and a slowdown in reopening the economy took its toll.  The Conference Board consumer confidence index fell to 92.6 in July from 98.3 in June and 135.8 a year ago.  The University of Michigan consumer sentiment index fell to 72.5 in July from 78.1 in June and 98.4 a year ago.
  • Manufacturers’ new orders rose 7.3% in June.  They are still down 12.7% from a year ago.  But, given the higher COVID infection rate in July, states clamping down as a result and the CARES Act expiring, the outlook has become considerably less positive. 
  • The FED reinforced its commitment to supporting the economy.  Short term rates remain at 0.0% to 0.25%.  And the FED will keep its spending at $120 billion per month to support the economy.  It is using every trick it can think of to support markets.  The FED will also peg rates beyond short term rates and is likely to peg the 10-year Treasury rate at 0.5%.  The problem with this, though, is that there will no longer be market signals from the bond market.
  • The NAR pending home sales index jumped 16.6% to 116.1 in June.  This is the highest level since 2006.  Potential home buyers are entering the market in force.  National pending home sales were up 6.3% from their year ago level.
  • The S&P/Case-Shiller home price index rose 3.7% year over year in May for the 20-city composite index.  The April to May gain was 0.4%.

Arizona Snapshot:

  • Initial claims for unemployment insurance fell for the second week in a row the week of July 25th.  But, initial claims were still up 413.5% from a year ago.  The 825,623 Arizonans who filed claims since mid-March represent 27.7% of total March employment.
  • Total air traffic at Sky Harbor about doubled in June when compared to May.  1,102,143 passengers went through Phoenix’s major airport in June.  This compared to 584,283 in May.  The June figure is still down 71.2% from a year ago.
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August 2020