'Zarnowitz Rule' lives on
Despite Q3's blowout GDP figure, the U.S. likely will need a few more quarters to break even.
Bottom line The late Victor Zarnowitz, a legendary professor of economics at the University of Chicago and renowned business-cycle expert at the National Bureau of Economic Research (NBER), is best known for his seminal work studying post-war recessions. His oft-quoted conclusion is that the deeper the recession, the steeper the recovery. This certainly has played out this year so far. The Commerce Department reported yesterday that the U.S. economy rebounded with vengeance in the third quarter, as gross domestic product (GDP) soared by a stronger-than-expected 33.1% quarter-over-quarter (q/q) annualized (7.4% q/q non-annualized), marking the single largest quarterly economic expansion since record-keeping began in 1947.
This powerful rebound was paced by other sharp improvements, including a 40.7% surge in personal consumption (a record), a 20.3% gain in corporate capex, a 59.3% increase in housing (the strongest since 1983) and a $1 billion liquidation in inventories, modest when compared with the massive liquidation of $287 billion in the second quarter. On the negative side of the ledger, net trade and government spending across the board detracted from GDP during the third quarter.
Second-quarter GDP plunged 31.4% q/q annualized (down 9% q/q non-annualized), marking the single largest economic contraction in U.S. history. This pushed the economy into its deepest recession on record, which started in February, according to the NBER, as the economy went into lockdown in March to help prevent the spread of the coronavirus. We believe that the recession ended in May or June, so we’re now just patiently waiting for the NBER to officially date its conclusion.
Today’s terrific GDP flash actually was stronger than the Bloomberg consensus of 32%, the Blue Chip consensus of 29.1% and our own forecast here at Federated Hermes of 32.3%. The Atlanta Fed’s GDPNow forecast was 37%.
Are we whole yet? U.S. GDP now approximates $21.158 trillion in current dollars, 2.7% below the fourth quarter of 2019’s $21.747 trillion, the last “normal” quarter before the world went to hell in a handbasket due to the pandemic. In chained dollars, third-quarter GDP now approximates $18.584 trillion, 3.5% below the fourth quarter of 2019’s $19.254 trillion. So, while we’ve made considerable progress climbing up our economic chasm—recovering about two-thirds of the growth deficit—we expect growth to moderate and begin to normalize from the third quarter’s breakneck pace. That suggests we’ll need a few more quarters to get back to break even, perhaps by the middle of calendar 2021.
Election implications? To be sure, the third quarter’s enormous rebound should have positive implications for next week’s contentious election, as it provides justification for Trump’s strong fiscal policy stewardship. But 77 million voters have already cast ballots (out of an estimated 150-160 million total) through either mail-in or early in-person voting. Of the half who haven’t, how many undecided voters will be positively swayed by this strong GDP figure? And will they be enough to give Trump an electoral college bounce in several swing states?
Third-quarter earnings following GDP growth We’re roughly two-thirds of the way through the third-quarter reporting season, and S&P 500 results to date have been much stronger than expected. Revenues have declined only 1.7% year-over-year (y/y), with 78% of the companies that have already reported beating consensus estimates by an average of 2.7%. Earnings were expected to decline 21% y/y, but have only fallen 6.1% thus far, as 84% of the companies that have already reported are beating consensus estimates an average of 19.2%. That is the second highest beat rate on record, trailing only this year’s second quarter.
Employment also rebounding At 751,000 for the week ended Oct. 24, initial weekly jobless claims have now fallen 89% from their peak in late March, and they’ve decreased nearly half from 1.435 million in late July, when the weekly $600 unemployment bonus expired. Importantly, at 7.756 million for the week that ended Oct. 17, continuing claims have fallen 69% from their peak in mid-May, and they’ve also declined by slightly more than half from 16.1 million since the bonus expired. Consequently, the unemployment rate (U-3) has fallen sharply to 7.9% in September from the peak in April of 14.7%. But because of the significant improvement in the claims data, an important leading indicator for employment trends, October’s unemployment rate (reported Nov. 6) might fall below 7%.
Some details of the third-quarter GDP report:
Personal consumption (accounting for 70% of GDP) soared by a stronger-than-expected 40.7% in the third quarter (accounting for 25.27 percentage points of the gain in overall GDP), versus a decline of 33.2% in the second (the steepest decline on record). As we began to reopen the economy, consumers had enormous pent-up demand, an elevated savings rate and generous fiscal stimulus from the federal government. Auto sales and the Back-to-School retail season were both strong, and we’re expecting a relatively solid Christmas season, which started in October.
Corporate capital spending rose sharply by 20.3% in the third quarter (adding 2.88 percentage points to GDP), compared with a decline of 27.2% in the second quarter, its steepest decline since 1952. But the third quarter’s strength was uneven. Equipment surged 70%, but structures declined almost 15% and intellectual property slipped 1%.
Housing soared 59.5% in the third quarter, its strongest quarter since 1983, goosed by record-low interest rates and strong demand. That added 2.09 percentage points to GDP, and compares quite favorably to a decline of 35.6% in the second quarter, its worst result since 1980.
Inventory accumulation actually slipped by $1 billion in the third quarter, but that was light years better than the aggressive liquidation of $287 billion in the second. That sequential improvement added 6.62 percentage points to GDP. This positive trend should continue, as depleted inventory must be replenished heading into Christmas and beyond.
The worsening net trade picture reduced GDP by 3.09 percentage points overall. Exports soared 59.7% in the third quarter, compared with a sharp 64.4% second-quarter decline. But imports surged 91.1%, significantly outstripping the gain in exports, compared with a second-quarter decline of 54.1%.
Government spending declined 4.5% in the third quarter, as the administration and Congress were unable to agree on a Phase 4 fiscal stimulus package. This subtracted 0.68 percentage points from GDP. Net government spending had increased 2.5% in the second quarter, as the massive fiscal policy stimulus in the wake of the coronavirus boosted nondefense federal government transfer payments to individuals and businesses by 37.6%, compared with a decline of 18.1% in the third. State and local spending declined 3.3% in the third quarter and 5.4% in the second.
Private domestic final sales, which exclude volatile net trade, inventory building and government spending, surged 38.1% in the third quarter, versus a 32.4% decline in the second. This metric is a better indication of the economy’s underlying fundamental strength.