Looking Beyond COVID-19 — Observations Post-Election Morning
With some trepidation, we issue this commentary Wednesday morning post-election day. With obvious risk, current trends this morning suggest former vice-president Biden ahead, but the outcome remains uncertain. At the same time, the Senate will likely remain narrowly in Republican hands. No matter which presidential candidate wins, a divided government will result. Figure 1 shows a divided government in Washington historically produces above-average equity market performance. Two final observations. Our prior commentaries suggested successful vaccine testing in the fourth quarter would prove more important to the economic outlook for 2021-22 than the election. Our opinion remains unchanged. Finally, the pollsters come out the big losers calling for a blue wave.
Post-Election – Slowing Economic Growth Absent Fiscal Stimulus — Cyclical Industries’ Gains Should Sustain Modest Fourth Quarter Economic Momentum
The strength of third-quarter consumer spending reached nearly pre-pandemic levels. Absent new incremental fiscal spending from Washington in the fourth quarter with the increasing political uncertainties and the growing COVID-19 spread, sequential quarterly economic growth will likely flatten. Nonetheless, growth in cyclical industries such as housing and autos, as well as inventory rebuilding, should still continue to sustain modest fourth-quarter economic momentum. However, if more aggressive spreading of the virus causes regional lockdowns, more muted economic activity will likely result.
Figure 2 shows the Atlanta Fed’s GDPNow forecasts, which show the range of Blue-Chip Financial Forecasts and illustrates the downward trend of forecasts. The GDPNow forecast also includes the Atlanta Fed’s outlook represented by its running estimate based on the most current economic data.
Post-Election Economic Outlook— Increased Fiscal Stimulus Spending Proposals Moderated by Divided Government
With continuing divided government, the Washington political class will likely move forward with at least $2 trillion of incremental fiscal spending proposals. This will prove less than seemed likely with a more decisive election outcome and will likely take more time to enact. If Biden comes out victorious, how he works with the House Democratic coalition of progressives and moderates will determine his ability to move this stimulus and other programs through a more politically balanced Senate. Nonetheless, substantial new stimulus spending for several programs will likely be enacted early in the first quarter of 2021. With that likelihood, first-quarter economic growth should show sequential growth compared to fourth-quarter results.
Higher Tax Rates Still Likely Later In 2021 or 2022 —But Scaled Back
Since President Trump would not likely propose higher tax rates, for purposes of our analysis, we look to the Biden tax agenda, which includes higher tax rates on corporate and some capital gains. If the Senate remains in Republican hands, the Biden tax proposals will likely be scaled back substantially. No doubt, the rapid rise in deficit spending would result in calls for greater tax revenues from both sides of the aisle. The likely smaller fiscal stimulus package plus potential revenue-raising measures could produce a more modest deficit increase. With the economy still in recovery, even limited tax rates increases will not likely rollout until later in 2021 or in 2022. If that proves the case, with the cyclical recovery likely picking up speed by that time, possible higher corporate tax rates could be partially offset by improving pre-tax earnings.
Post-Election—Service Sector Key to Long-Term Economic Recovery
The service sector normally contributes nearly 70% of GDP. During a typical recession, service sector spending acts as a buffer to moderate economic declines. Unlike typical recessions, this pandemic caused recession resulting in government-mandated lockdowns brought consumer service spending grinding to a halt (see Figure 3).
U.S. Consumer Spending Recovery Still Incomplete
Percent Difference from February
Source: Oxford Economics/Haver Analytics, Daily Shot
Vaccines Key to Returning Life to Consumer Services and Reducing Substantial Levels of Unemployment
With broad-based vaccine distribution likely by mid-year, the important consumer service sector should see a rebirth. Many of these industries, including restaurants and bars, leisure activities, and travel, among others, depend on crowd density for their business success. Crowd density, at the same time, produced super spreading of the virus, forcing closings and then eventually opening but with significantly reduced capacities.
Shutting down many of these consumer services also produced the greatest increase in unemployment for any industry sector, particularly among low skilled workers. Sharply reduced consumer service business activities tempered the employment recovery of low-skilled individuals (see Figure 4), particularly in the leisure and hospitality industries (see Figure 5). A gradual rebound in consumer services in the second half of 2021 will likely prove meaningful to economic recovery in the second half of 2021 and for all of the following year.
Employment Recovery by Education Levels—Change from Feb. 2020
Source: Refinitiv Datastream, TS Lombard, The Daily Shot
The Pandemic Accelerated Introduction of Disruptive New Technologies—to the Benefit of U.S. Economic Growth
Beyond COVID-19 and with a vaccine, the “new century” will also continue to accelerate changes resulting from, among others, increasing use of digitization, automation, the broader commercial and industrial application of 5G networks, and the expanding influence of artificial intelligence and big data inputs. These influences will more quickly revolutionize and disrupt many industries and cause others to shrink or disappear. If this proves correct, U.S. productivity would likely improve when compared to the last decade — to the benefit of U.S. economic growth — as zombie corporations disappear.
Improving Cyclical Stock Outlook
With the election almost behind us, the fourth quarter will hopefully produce at least one successful vaccine and the likelihood of increased fiscal spending in the fourth or more likely early in the first quarter. Both a vaccine and new stimulus programs should lead to an improving economic outlook, particularly for the second half of next year and 2022. The economic outlook post-broad-based vaccine distribution will depend importantly on economic momentum pre-vaccine. With that outlook, we continue to expect a broadening positive outlook for cyclical stocks for some period of time.
Rapid Disruptive Technological Changes May Limit Potential for Traditional Value Stocks
Many investors also look to traditional value stocks in this environment. We expect more rapid disruptive technological forces resulting from the changes brought about by COVID 19 will likely reduce the economic values of many assets carried on the balance sheets of such companies. In our opinion, this may limit the recovery for many such traditional value stocks beyond simply their cyclical recovery.
Longer-Term Debt Overhang Could Reduce U.S. Sustained Growth Rate — That Outlook Favors Growth Stocks Beyond the Initial Economic Recovery
Both likely new fiscal programs and hoped for broad-based vaccine distribution should lead to a cyclical recovery into 2022. Rapidly increasing debt hangover resulting from funding new fiscal programs will likely lead to reduced long-term potential growth for the U.S. economy. Very simply, the declining marginal economic benefit from incremental debt issuance will likely lead to slowing GDP growth. If this proves correct, then financially strong quality companies with a foreseeable steady growth outlook make sense for investors past the first stages of economic recovery.
Cyclical Growth Leads to Rising Interest Rates—Stick With Shorter-Duration Debt
The cyclical recovery will likely lead to rising interest rates in reaction to possible signs of gradually increasing inflation. With that outlook, investors should stick with shorter-duration fixed-income investments. This will avoid the price risk longer duration debt faces from rising interest rates. With our long-term concerns that U.S. growth rates could once again become subdued, longer-duration fixed-income debt may, at that time, then become more attractive once past the recovery cycle.