July 17, 2020

Everyone remains concerned about the more rapid pace of spread of the virus.  But economists are being far too pessimistic. What killed the economy in the second quarter was our country’s response to the virus rather than the virus itself.  The nationwide lockdown was devastating.  While some selective closures will occur in the weeks ahead, they should be relatively few in number.  With an election coming any hint of a renewed economic slowdown will trigger additional fiscal stimulus.

Every economic indicator released in the past two months has been far stronger than expected.  The level for many indicators is back to where it was prior to the onset of recession in March.  If that is the case, third quarter GDP growth is likely to be as large as the decline in the second.  But that is not what economists are expecting.  They anticipate a huge decline in GDP growth for the year.  If third quarter GDP growth offsets the second quarter decline, that is not going too happen.   As the year progresses, we expect economists to revise upwards their growth forecasts for the year.

As the recession got underway in March and April it became quickly apparent that GDP was going to register a record-breaking decline in the second quarter.  At that time economists thought the recession would last eight months which would be about average.  We get our first look at the magnitude of the second quarter decline on Thursday morning, July 30.  We expect a drop of 50.0%.

But what economists did not expect was the speed and the magnitude of the snapback in response to the fiscal stimulus.  Given the dramatic gains in virtually every economic indicator in May and June, it is abundantly obvious that the recession lasted exactly two months – it started in March, continued in April.  By May it was over.  But yet, economists continue to expect a huge drop in GDP growth for the year.  That seems unlikely.

The Fed is probably a good example of the consensus view.  At the most recent FOMC gathering on June 10, Fed officials expected GDP to decline 6.5% in 2020.  By then they knew that first quarter GDP had declined 5.0%.  We do not know the quarterly pattern of growth they expected for the second, third, and fourth quarters.  But if GDP is going to decline 6.5% for the year, it is clear that their projected third quarter GDP growth rate would be only about one-half as large as the second quarter decline.  Given recent data, that is not going to happen.

For example, driven by a dramatic increase in the forward-looking components of orders and production, the purchasing managers’ index for the manufacturing sector is higher now than it was going into the recession.  Ditto for the non-manufacturing sector.

Dramatic increases in retail sales for May and June of 18.2% and 7.5%, respectively, boosted the level of retail sales back to where it was prior to the recession.  If, as expected, payroll employment to increases in July and the unemployment rate declines, it is a sure bet that retail sales will continue to climb in that month.

Homebuilders are as confident today as they were prior to the recession.  And why shouldn’t they be?  Traffic through the model homes has returned to its pre-recession level.  Mortgage rates have fallen to a record low level of 3.0%.  To satisfy demand builders are going to have to step-up the pace.  With lots of construction workers still unemployed they should be able to find enough bodies to make that happen.

Payroll employment has been dramatically stronger than expected in recent months.  Employment increased 2.7 million workers in May when economists expected a decline of 5.0 million.  It rose 4.8 million in June when economists expected an increase of 2.0 million.  Given the steady drop in initial unemployment benefits and the number of people receiving unemployment insurance benefits, we expect an increase of 4.0 million workers in July; the consensus is for an increase of 2.0 million.  Economists thought the unemployment rate was going to reach the 20% mark.  Instead, it peaked at 14.7% in April, declined to 11.1% by June, and is likely to far further to 9.4% in July.

You get the idea.  The economy has bounced back far more quickly and with considerably more vigor than anyone would have expected,

Given all of the above, we expect GDP to fall by 50.0% in the second quarter but then rebound by 51% in the third quarter as virtually every sector of the economy returns to its pre-recession level.  If all of that is correct, then GDP for the year is likely to decline by just 1.0% despite the most dramatic recession in history.  If the Fed and many other economists are currently looking for a GDP drop of 6.5%, we suggest they are being far too pessimistic.

What would change our minds would be the re-imposition of a nationwide or widespread local lockdowns.  But the president and governors can see the economic damage that such closures create, and neither has the appetite to knowingly inflict that pain on their state or the country.  If even a hint of a renewed slowdown emerges, additional fiscal stimulus will be quickly forthcoming.  Both political parties seem to agree that further stimulus will be required.

Stephen Slifer


Charleston, S.C.