Covid’s Economic Impact in the Coming Year
We all know the economic devastation wrought by COVID-19 last year. According to the U.S. Bureau of Economic Analysis, GDP fell by 3.5% in 2020. As seen in the chart to the right, GDP fell by an over 30% annualized rate in Q2 last year, only to sharply recover with a similar rate of growth in Q3 as the economy re-opened and fiscal stimulus kicked in. So, what will be the impact to economic growth in 2021 as we learn to live with the virus?
The good news is that more Americans, especially the most vulnerable, are getting vaccinated every day (at a rate of 1.3 million doses per day currently), which will allow the economy to more fully open up and travel to resume more broadly. The restaurant, entertainment and travel industries are the last segments of the economy to have yet to recover, so any resumption there will provide a strong boost to the economy and to employment. According to FactSet, economists now estimate that U.S. GDP will grow by 4.2% in 2021 – and, some of those economists predict growth exceeding 6%, a rate that would not surprise us.
The Biden administration is currently proposing a $1.9 trillion “Pandemic Relief” stimulus package, which looks likely to pass Congress in a partisan fashion. This stimulus will come on the heels of a $900 billion package passed just this past December and the $2.4 trillion Cares Act passed earlier in 2020. As seen in the chart below, courtesy of The Economist, the total stimulus would then amount to nearly $6 trillion, or about 25% of 2019 GDP, almost all of which is funded by additional government borrowings. Most of that new government debt is funded indirectly by an expansion of the Federal Reserve’s (Fed) balance sheet, something we have discussed before, and which has resulted in monetary growth recently exceeding an unbelievable 24% rate. With so much growth in the money supply, it is not surprising that we might begin to see rising inflation. Sure enough, as seen in the table to the right, the prices of many commodities are up over 20% since the beginning of 2020. Keep in mind that the Biden Pandemic Relief package also contemplates a near doubling in the minimum wage to $15 per hour, which will likely cause a rise in wages more broadly to account for a higher “entry level” wage rate.
Of course, the Fed is on record as saying they want inflation rates to exceed 2% and are willing to live with even higher rates for some time before considering raising the short-term Fed Funds rate. The question then becomes “can the Fed control the Inflation Genie once they have let it out of the bottle?”. If not, higher long-term interest rates would also be likely, as bond investors seek compensation for higher inflation. The implications of such higher rates would be detrimental to long-term bonds, as their prices go down when interest rates go up. Accordingly, we believe it makes sense to keep our bond ladders short and be prepared to invest those maturing bonds at possibly higher rates. We are also becoming more cautious about growth stocks (like the Nasdaq 100 stocks), which are sensitive to higher interest rates and are already trading at historically high valuations after posting phenomenal performance the past few years. In such circumstances, more value-oriented stocks should outperform the market, something they have not done in a long while, but whose time may have finally come.