The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2021 Outlook:
- U.S. economy: Getting worse before it improves.
- Global economy: Ready to get back to normal—with the help of vaccines.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: A modest-risk overweight with a focus on credit sectors.
- Equities: Lean toward small caps, emerging market shares and dividend payers.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
"Do not rely on February. The sun in this month begets a headache like an angel slapping you in the face." – Anne Sexton
The U.S. economy hit a speed bump last quarter but should accelerate from here
While the U.S. Bureau of Economic Analysis (BEA) has long reported quarterly GDP growth at an annualized rate, that practice obscures, rather than illuminates, the degree to which the economy actually expanded (or shrank) during the quarter being measured. Last week, for example, headline GDP growth for the fourth quarter of 2020 was reported as 4%. But that number is theoretical, a largely meaningless extrapolation of the quarterly data. In reality, U.S. economic output grew just 1% in the fourth quarter — a significant deceleration after growing 7.5% in the third quarter.3
With that caveat, let’s look at the contributors to the fourth-quarter’s modest expansion. Personal consumption, by far the largest component of U.S. growth, increased at a somewhat slower rate (+0.6%) than the economy as a whole.4 Households pulled back on spending in the face of rising COVID-19 cases, renewed closures/restrictions and falling incomes. Disposable personal income fell during the fourth quarter, as it did in the third, due to expiring federal aid programs. As a result, the personal savings rate dropped yet again, to 13.7% — still high by historical standards.5
The contribution from personal consumption was offset by detractions from trade and government spending. That left private investment as the primary source of growth for the quarter. We already knew that manufacturers and builders were thriving during the period even as consumers pulled back, but the GDP report now quantifies this for us. About 25% of fourth-quarter GDP growth was inventory restocking, goods that are produced but not sold during the quarter. The remaining 75% was pretty evenly split between nonresidential investment (e.g., structures, equipment and intellectual property, of which equipment was the largest component) and residential investment.6 These parts of the U.S. economy are less susceptible to the impacts of the virus and are likely to continue supporting growth well into 2021.
In terms of trade, both imports and exports rose significantly, but imports rose by more, resulting in a net drag on GDP. American consumers are buying lots of goods these days, and they like to buy goods from abroad: Spanish wines, Korean televisions, German beer, Chinese toys and so on.
Government spending, meanwhile, declined as federal stimulus provisions expired and were not renewed by quarter-end. At the same time, state and local governments were under at least some pressure to tighten their budgets. As a result, final sales to domestic private purchasers, which some economists rely on as a more definitive measure of economic health (because it strips out the impact of trade and government spending) grew at a higher rate than the overall economy.
Drilling down specifically into December’s consumer numbers, which were released this past Friday morning (a day after the quarterly GDP data), personal income rose while spending fell, boosting the personal savings rate in the final month of the year.7 Core inflation, which strips out volatile food and energy prices, surprised on the high side (+0.3%) in December, after coming in flat in October and November.7 (Year over year, December core inflation was up 1.5%.)8 The Fed made it clear last week that it will disregard one-off inflation surprises and other temporary anomalies as it assesses the appropriate path of monetary policy this year.
How did the U.S. economy perform for 2020 as a whole? GDP ended the year 2.5% lower than it was at the end of 2019, in line with a 2.6% drop in consumer spending.9 Private investment grew by 3.2% over the course of the year, thanks to a 13.7% boom in residential construction.10 Government spending in aggregate fell 0.6%, as state and local outlays shrank at roughly the same rate that federal expenditures grew.11
Lackluster government spending growth in the fourth quarter and for the full year masks the absolutely critical role of federal fiscal stimulus in supporting incomes and propping up demand in the second quarter. That this relief was allowed to expire in the back half of the year doesn’t change the fact that government action forestalled a far worse economic crisis through the initial months of the pandemic.
That support remains evident in the higher personal savings rates that endure to this day, as well as rising household net worth in the form of home prices and investment balances. Indeed, savings rates are already higher at the end of January than they were at the end of December, reflecting the additional $900 billion in federal relief passed over the holidays. And while details remain subject to negotiation, more fiscal aid is apparently on the way. This, along with the vaccines, fuels our optimism as we move further into 2021.
A quiet start to 2021 for the Fed
After a string of dovish policy moves throughout the second half of 2020—including an expressed willingness to tolerate inflation above its 2% target for an extended period of time—the Federal Reserve opted to stand pat at its first meeting of 2021, held last Wednesday. No new policies were announced and none are expected for a while, as the Fed evaluates the path of COVID-19 and its ongoing effect on the economy.
The Fed’s post-meeting policy statement contained few changes to the one released in December but notably acknowledged that the pace of the U.S. economic recovery had moderated. This was likely a reference to, among other things, the 140,000 drop in non-farm payrolls in December. (With the release of the January jobs report this coming Friday, we’ll see whether and to what extent the labor market bounced back to start the year.)
In his press conference, Fed Chair Jerome Powell was pressed on when the Fed might begin to taper its pace of quantitative easing (QE) asset purchases, currently at $120 billion per month (made up of $80 billion in U.S. Treasuries and $40 billion in mortgage-backed securities). Powell stressed that such talk was “premature” and that it would be “some time” before the economy would make substantial enough progress toward the Fed’s goals of full employment and 2% average inflation to consider slowing down those purchases. Therefore, we expect QE to remain in effect at least through 2021. In our view, dialing back QE while the economy is still recovering would rattle markets, sending longer-dated Treasury yields higher, stock prices lower and credit spreads wider — similar to what happened during the “taper tantrum” of 2013.
Regarding the Fed’s previous calls for additional fiscal stimulus to support the economy, President Biden has already announced a $1.9 trillion relief package to help households and businesses affected by the pandemic, as well as to tackle longer-term issues related to income inequality and child poverty. If enacted, these measures would likely boost GDP growth even further in 2021 and 2022, bringing the economy back to, if not above, its potential sometime in the next few years.
A stronger economy could drive inflation higher through accelerating wage growth, particularly for those at the lower end of the income scale, similar to what we saw in 2018 and 2019. Given the Fed’s flexibility toward inflation, Powell and his colleagues would likely welcome more fiscal stimulus. They’ve emphasized that the U.S. labor market still has considerable slack: unemployment remains at 6.7%, and more than 4 million workers have left the labor force in the past year.12 Those are signs that the economy is at little risk of overheating any time soon. And as long as those conditions remain, we doubt the Fed will announce that it’s even considering tightening policy.