We just experienced the strongest quarterly growth rate in U.S. history. Why are so many still worried?
>> Quick takes:
- Economy rebounds strongly in third quarter
- But GDP remains 3.5% below end of 2019
- Technical recession likely ended this summer
- Risks remain skewed to the downside
- Growth is positive for CRE, but investment in nonresidential structures declining
Last week’s advance reading of third quarter real GDP confirmed what we already knew. The economy snapped back, registering the strongest quarterly growth rate in U.S. history. We strongly believed that this was coming and it slightly exceeded expectations. Annualized growth registered 33.1%, almost the mirror image of second quarter’s decline of 31.4%. But perspective is important. The quarter-to-quarter growth rate of 7.4% leaves the economy 3.5% smaller than it was at the end of 2019. That roughly equates to the peak-to-trough contraction of 4.0% during the Great Recession (which incidentally no longer seems so great by comparison).
The details proved quite informative. On the positive side of the ledger, consumption spending rebounded strongly across goods and services. The partial reversal of shutdowns and lockdowns from earlier in the year, coupled with the increased willingness on the part of consumers to spend money, boosted growth. Private investment also bounced back, led by residential housing and equipment. On the negative side, investment in commercial structures and intellectual property continued to decline. The trade balance widened to its largest deficit on record with imports growing far faster than exports. And government spending eroded further with notable declines in federal nondefense spending and state and local spending.
What we still don’t know, but might
Though instructive, the release provided no real guidance on what we do not yet know – where the economy is headed. We continue to believe that the technical recession ended this summer and that the economy remains on a recovery trajectory. Our base scenario forecast projects no further quarterly contractions in GDP and economic growth of roughly -4% in 2020 followed by 4% growth in 2021. If so, that would render this recession one of the shortest (if not the shortest) on record despite its severity. It would also make this recession different, an outlier. Typically, the magnitude of contraction in the economy positively correlates with duration. Essentially, longer downturns mean more severe downturns. The peak-to-trough decline in real GDP of 10.1% and the maximum unemployment rate of 14.7% makes this recession one of the most severe in U.S. economic history. Yet, the period of contraction should register roughly six months (give or take), far shorter than the 24 months implied by econometrics for this magnitude of severity - a silver lining amidst many dark storm clouds.
Duration correlates with severity
Yet the base scenario heavily rests on two key assumptions that remain fraught with unquantifiable uncertainty. First, the outlook assumes that the pandemic, while resurgent, does not necessitate the stern measures implemented earlier this year to limit the outbreak. Governments will likely have to return to the use of less dire tactics such as partial shutdowns, capacity constraints and curfews. But we note that several countries in Europe have already reinitiated some draconian measures to halt the spread of the virus and clarity on the pandemic’s trajectory remains limited. Second, the outlook also assumes that another major fiscal stimulus package will pass sometime in the next six months. As we have reiterated, the economy will struggle to self-correct until the pandemic ends and the absence of additional stimulus could undermine the nascent recovery. The contraction in government spending, particularly at the state and local level, serves as a harbinger of trouble if holes left in state and municipal budgets are not filled via help from the federal government.
Unfortunately, these two key assumptions create an asymmetrical risk distribution that skews to the downside. A trajectory that includes no additional fiscal stimulus and/or more intense government edicts to control the outbreak seems possible if not the most probable path forward. But, an upside scenario (e.g. abating pandemic, outsized and timely fiscal stimulus), while also possible, seems much more improbable given: (1) the current path of the pandemic, (2) the time needed to approve, manufacture, and distribute an effective vaccine or therapeutic, and (3) the political environment in Washington.
| What we are watching this week |
Three key pieces of information will provide some guidance on how the economy began the fourth quarter. The ISM Manufacturing index for October should increase at a robust pace, reflecting the ongoing recovery in the sector. The ISM Nonmanufacturing index for October should also increase but at a slower pace. And the employment situation for October should show a relatively large net job gain, likely near 600,000, but continue to reflect a deceleration in job growth.
| What it means for CRE |
For commercial real estate, stronger economic growth remains a tailwind for the sector, all else equal. But within the details, the contraction in nonresidential investment presents a double-edged sword. This decline will mean less construction in the sector, including new development, redevelopment, and tenant improvement work. On the other hand, lower supply growth during a downturn will modestly help support space market fundamentals like asking rents and vacancy rates while also modestly supporting capital market metrics like cap rates and prices.
| Thought of the week |
The Baby Boom generation controls roughly 50% of all wealth in the U.S. while representing approximately 31% of the population.