An optimistic Outlook after Reflecting on the Global Economy’s Challenges.

November 25, 2020

We have reached maximum ZOOM exhaustion after a week of end to end on-line conferences. We started with a three-day whirlwind review of the global economy by 45 of the world’s top industry and business economists, as National Business Economic Issues Council (NBEIC) members each gave their best ten minutes on their area of expertise. On Thursday, we participated in two Global Interdependence Center (GIC) calls. The first, an organizational meeting for the College of Central Bankers, where 11 top former monetary policy decision makers from the US, Europe and Latin America and their advisory council planned future discussions. Later that afternoon was GIC’s 38th Annual Monetary & Trade Conference featuring Danny Blanchflower, Mickey Levy, Michael Gapen and Mark Zandi. Clearly, we learned a lot – most importantly, that the range of views on the immediate future of the US and global economy has never been more disparate. Some, like ourselves, see strong growth just ahead as manufacturers try and catch up with stronger than expected – so far – consumption. Others fear a second wave and renewed shutdowns, with some seeing renewed recession in early 2020 unless significantly more monetary and fiscal stimulus is forthcoming. After penning this week’s missive, a bit early, we look forward to a quiet weekend, and week ahead, with lots of football, one extended ZOOM meeting with the widespread family on Thanksgiving, and our own 65th birthday on Saturday – and then right back to work as new information on holiday spending, the pace of the Presidential transition and Congressional negotiations become clearer.

Even after listening to a week of reasoned discussion about the global economy’s challenges, we remain at the optimistic tail for near-term US economic growth – and among the few that expects improved US (but not global) potential growth post-COVID. For the near term, we are merely watching the data, which continue to outperform. Sizable upward revisions to retail sales for August and housing starts for September will likely add to the 33% growth rate originally reported for the third quarter – and help produce a double- digit gain in the fourth quarter. That combination should put US real GDP above year ago levels sometime in the first quarter – much earlier than consensus expectations. China has already achieved crossover, and is running near year ago growth rates. It is Europe, where the second wave is currently strongest, and the unanimous vote requirement for any additional EU activity is presenting the greatest economic risk. We expect the fact that China will soon surpass Europe in global economic clout will be one of the most important factors in global policy and development in the coming decade.

Longer term, we believe the innovations generated by COVID – work from home, rapid development of medicines via public-private cooperation, greater connectivity through tele-learning, tele-medicine, tele-meetings, better logistics – and many more areas where earlier apparent cost hurdles have been eliminated sooner than expected will create a Space Race like environment with strong productivity growth. This will also create significant issues for inequality and displacement – as many economic crises have in the past. We believe that politics will play a significant role in how the corporate savings from racing down the cost curve will be re-allocated. Whether that happens with a turbulent Washington or a co-operative one waits to be seen. Notably, many of these innovations that should boost US growth may not in China or Europe, as their political systems are more resistant to change.

The conclusion from this week’s data flow is that US manufacturers are still struggling mightily to catch up with consumer activity that has been far stronger than they expected. Unlike typical post-war recessions, the COVID shock was far more about supply than demand – as the shutdown in March stopped virtually all production of both goods and services, but massive stimulus preserved buying power. Once the lockdown ended, producers needed to both replace depleted inventories and catch up to spending that had been buoyed by transfers. However, COVID restrictions were harder on re-opening businesses than on consumers, who often had incomes that were higher than they would have been normally. Now, as stimulus evaporates, spending is being maintained by savings built up from unspent income, and even more from massive asset appreciation, as both equity markets and home values have increased by over 15%. Aggressive hiring by firms, paying higher wages as the job mix shifts away from services to goods production, is creating more income in a virtuous spiral. Bottom line, manufacturers are still far behind the curve, as indicated by recent strong ISM and Philadelphia Fed readings. This month’s 1.0% rise in manufacturing production exceeded the modest 0.3% gain in retail sales – however, it failed to offset the gap generated during the two previous months, when retail sales grew 3.0% and industrial production rose just 1.4%. With inventories flat in the third quarter after a massive $280 billion annualized selloff in the second quarter, manufacturers will have to outrun consumption — by a magnitude — to close this gap in even a year’s time.

In estimating fourth quarter growth, we note that even if retail sales remained unchanged from the October level, they would be 7.2% higher at an annual rate than the third quarter average. If they grew at the previous three- month average of 1.1%, they would be 12.0% higher. The CPI for goods fell -0.1% in October and remains -0.4% behind a year ago. Thus, we expect a close to double digit contribution to real growth from retailers’ one-half of consumption (and one third of total GDP). Meanwhile, October existing home sales were up a whopping 26.6% from a year ago and the average price rose 12.9%, pushing transaction value up a stunning 43%. Single family housing starts are up 65% over the past year as builders struggle to keep pace. The $642 billion increase in transactions on existing homes in the past year is nearly double the $354 billion gain in retail sales. Bottom line, personal consumption expenditures may be running -3% behind a year ago, but total household outlays for goods, services and housing (both new and existing units) are more than 5% ahead! The fact that much of the housing is financed makes little difference to manufacturers of building supplies and housing related goods – or their employees — so long as they get paid by someone. While many fear shutdowns from a second wave of COVID, we note that would likely drive an even stronger housing market as urban dwellers flee the cities.

A similar calculation for industrial production indicates that if factory output were flat from October’s level, it would rise 6.2% in the fourth quarter. If it continued to expanded at the 0.8% average of the past three months, it would rise 9.2%. However, if it rose 1.1% — to just match consumption (never mind close the gap) it would contribute a 10.9% annualized gain to fourth quarter real GDP. Bottom line, we expected inventories will rise in the fourth quarter, with output exceeding consumption, so we are sticking to our call for double digit growth.

Another factor supporting our view this week was ongoing declines in continuing claims for unemployment – which we interpret as primarily due to job growth. For the most recent week with complete data (three weeks back) continuing claims plus rollover PEUC claims fell by 142,000. This is smaller than most recent weeks, but PEUC increases of 100,000 in Pennsylvania and a 34,000 gain in Hawaii appear to be outliers. PEUC claims had been declining following the path of original COVID initial claims 26 weeks earlier. This week PEUC claims rose from 155,000 to 233,000. Almost half the rise was due to Pennsylvania. The big rise in Hawaii reversed a decline in the previous week. If we wash the Hawaii flip-flop and adjust for Pennsylvania, we get -400,000 in combined claims four weeks ago and -250,000 three weeks ago. Two weeks ago, regular continuing claims fell -418,000, and with an expected +150,000 in PEUC claims we expect combined claims will have fallen by more than -250,000 again. Bottom line, in the three weeks of the November employment survey period, combined claims appear to have fallen 900,000 already. That should continue the run of roughly 900,000 new private jobs averaged over the past three months. That suggests hours worked will again rise by double digits in the fourth quarter, implying 10%+ real GDP growth without any productivity growth. Output per hour continued to rise in the manufacturing sector, suggesting ongoing gains for the entire economy. Note, hours worked project even more strength in real GDP growth than either retail sales or industrial output. Is that telling us something about the rest of the economy?

Finally, this week’s high frequency indicators from the NY Federal Reserve Weekly Economic Indicator and signaled ongoing – but slowing – progress in the expansion. Over the past two weeks, the NY Fed’s WEI has only eased up from -3.18 to -2.84 compared to a year ago. This has cooled the quarterly advance from 3.6% to 3.3%, pushing the crossover date to the end of January. Similarly, the measure of consumer spending improved to -4.5% (compared to the January level) from -6.5% last week — but both are weaker than the -3.7% average for the three prior weeks. We do not doubt that economic momentum is slowing as COVID ramps up again. The questions are how much, how fast, and how widespread. Two weeks of softer data is not enough to offset the very strong momentum imparted by production trying to catch up with demand. However, it does lead to questions on how strong first quarter and first half growth may be.

In defense of our out of consensus optimism, we note that the Atlanta Fed’s mechanical GDPNow tracker has risen sharply from 2.2% to 5.6% as the new data has rolled in. We are pleased that we are not alone at the over 10% mark, as our friends Michael Lewis of FMI in Chicago and Jim Smith of Parsec in Asheville are both in that camp as well – if not even more optimistic. In addressing the risk from a second wave of shutdowns, we question whether this second bite of the apple can be anywhere near as sour as the first. The shutdowns are far more limited geographically and primarily targeted at high contact services, like restaurants, bars, salons, gyms etc. These establishments were barely open and rarely profitable in recent months. Closing them back down is more a COVID related headline than a real blow to the economy. True, some schools are closing and that generates day care problems. But we have seen few indications that workplaces are closing, which is what undermined the economy in the first wave. Bottom line, we read the renewed shutdowns as trimming some of the optimism off of the first quarter – but that sets the stage for stronger growth later in 2021 when vaccines are distributed. We would not reduce our overall 2021 forecast on current shutdowns — unless we lost optimism on vaccines.

It is often difficult to talk about winners during an economic calamity, but as during wartime, when government is willing to fund a concerted effort toward a specific goal, the flood of money raises many boats. This has been the lesson from China for many years. The second lesson, is that many unexpected and often unrelated innovations occur once necessity forces entrepreneurs to think outside the box. Finally, while many worry about what will happen to these COVID winners when a vaccine returns the world to normality, we believe that pent up demand for COVID losers will provide enough offset. The key is access to funding – not necessarily from government subsidies – and the Fed has made it clear that short rates (where businesses fund working capital) will stay low for the foreseeable future. We expect many household startups will be financed by the recent surge in home equity. As before the Great Financial Crisis, home equity makes it far easier to start a business, because the bank is protected by your asset rather than your business acumen. This generates a boom-bust environment, where bad investments often pave the way for future successes from second owners who buy in at a discount. Bottom line, when rapid innovation occurs, we see the glass as half full. We recognize that many will suffer from these changes, but as history has shown repeatedly a combination of free markets and democracy will rearrange the reallocation of the upside to cushion the blow. Many have lost faith in both capitalism and politics. We still believe – in both.

Have a happy – and healthy – Thanksgiving. We will be taking a sabbatical from writing (and ZOOM) next week.

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