We expect third-quarter GDP growth to be the strongest in U.S. history.
Bottom Line We plunged into the deepest recession in history in February due to the pandemic and suffered through the worst quarter in history for both GDP and corporate profit growth in the second quarter. But we have experienced a powerful measure of economic redemption in the third. We are patiently waiting for the National Bureau of Economic Research (NBER) to officially date the end of the recession, but we think it likely ended in May or June.
Moreover, third-quarter corporate results are coming in much better than expected, for the second quarter in a row. We’re a little more than a quarter of the way through the reporting season, and while revenues have declined 4.6% year-over-year (y/y), 77% of the companies reporting thus far have produced a positive surprise by an average beat of 2.9%. Earnings also have declined 12% y/y, but 83% of the companies reporting have produced a positive surprise by an average beat of 17.7%, rivaling the stronger-than-expected second quarter’s record beat rate of 22.5%. Consensus expectations going into the third quarter were for a 21% y/y decline in profits.
Finally, we now think next week’s third-quarter GDP flash will show a record gain of 32.3%, marking the best quarter in history. That compares quite starkly with the second quarter’s record decline of 31.4%. Coming less than a week before the presidential election on Nov. 3, the strength or weakness of next week’s GDP report could have important election implications.
Powerful economic recovery After bottoming in April, the economy has recovered sharply over the past six months, led by the labor market, housing, autos, manufacturing, and consumer spending, reversing some of the coronavirus-inflicted damage:
- Housing The housing market index (HMI), which tracks builder confidence, surprisingly leapt to an all-time (35-year) cycle high of 85 in October 2020, due to lower mortgage interest rates and strong demand. New- and existing-home sales have surged into September to 14-year cycle highs. Housing starts and permits are similarly at new 14-year cycle highs.
- Autos Total U.S. vehicle sales declined 49% in April 2020 to 8.6 million annualized vehicles, down sharply from 16.8 million in February. But auto sales have since rebounded strongly, surging by 90% from that April trough to 16.3 million annualized units in September 2020.
- Consumer spending Retail sales expanded for the fifth consecutive month in September by their fastest month-over-month pace since June, as consumers finished their Back-to-School (BTS) shopping with a flourish, rising a solid 3.6% on a y/y basis in 2020. This bodes well for the elongated holiday shopping season that started this month. Christmas retail sales usually are 80-90% positively correlated with BTS results, so Deloitte’s high-end forecast of a 2.5-3.5% increase for holiday shopping in 2020 (versus 4.1% in 2019) looks promising. A surge in e-commerce sales should help to drive Christmas spending, as Deloitte is forecasting a 25-35% y/y gain, compared with 14.7% in 2019. Business and consumer confidence has strengthened over the past six months, supporting our views of a solid holiday season.
- Employment Initial weekly jobless claims and continuing claims have plunged by 89% and 69%, respectively, from their peaks in late March and mid-May, suggesting that the labor market gradually continues to heal. In addition, the unemployment rate (U-3) plunged to 7.9% in September, down sharply from its peak in April at 14.7% (the single worst month for the labor market since record-keeping began in 1939). That pace of improvement over the past five months is quadruple the strongest previous gains in the history of the labor market.
- Manufacturing The ISM manufacturing index plunged deep into recession territory (below 45) at 41.5 in April 2020 (a new 11-year low), but surged back into growth territory over the next four months to a 2-year high at 56 in August. All six of the regional Federal Reserve indices that we monitor have followed a similar pattern over the past six months. In addition, while factory orders, industrial production and capacity utilization, and durable and capital goods orders and shipments all suffered waterfall declines in March and April, they have bounced back strongly through August. Moreover, the sharp inventory liquidation we experienced during the first half of this year should shift gears into strong inventory restocking in the third quarter.
Third wave accelerating? To be sure, we have experienced a third-wave spike in coronavirus infections across the country over the past two months, in part because college students returned to campuses. But we’re also making strong progress on vaccine development, and we likely will have one or more vaccines available for limited emergency use by year-end, with a ramp-up in production over the course of calendar 2021.
More equity-market volatility on tap? As a successful forward-looking discounting mechanism, stocks have already priced in much of this economic and corporate profit rebound with its powerful 63% rally from March 23 to Sept. 2 (largely driven by technology stocks). In our view, the near-term equity-market picture has gotten considerably cloudier since Labor Day, and we expect greater volatility and uncertainty over the next several months.
Bush/Gore redux? The presidential election is less than a fortnight away and the prospect for a close and contentious contest has heightened. It is unlikely we will know who won the presidency and who controls the Senate on election night. In fact, with an expected record 70-80 million mail-in ballots—which could approximate half of all ballots cast—it may take several weeks to tabulate results. The last time we saw such election uncertainty was in 2000 with the Florida hanging chads. The S&P 500 declined about 13% over the next six weeks until the Supreme Court stepped in to resolve the issue.
Raising our third-quarter GDP estimate The equity, fixed-income and liquidity investment professionals who comprise Federated Hermes’ macroeconomic policy committee met on Wednesday to discuss the pandemic, the election and the strong improvement from the deepest U.S. economic recession in history:
- The Commerce Department will flash third-quarter 2020 GDP Thursday, Oct. 29. We believe the NBER will date the end of the recession at May or June, due to the powerful recovery in the labor market, autos, housing, consumer spending and manufacturing since the economy’s trough in April. We’re also expecting a significant inventory build during the third quarter. So we raised our third-quarter GDP growth estimate from 23.2% to 32.3%, which would be the strongest quarter in history (in stark comparison with second-quarter GDP of -31.4%, the worst on record). The Blue Chip raised its estimate from a gain of 24% to 29.1% (within a range of 22.8% to 34.1%). The Bloomberg consensus is now 31.9% and the Atlanta Fed’s GDPNow forecast is 35.3%.
- We continue to expect there will be at least one vaccine for limited emergency use by year-end, and we are now more optimistic regarding Christmas spending, in light of the much stronger-than-expected BTS season. But given our significant increase in third-quarter GDP, we adjusted our fourth-quarter 2020 growth estimate down from 8.9% to 4.5%. The Blue Chip has lowered its estimate from a gain of 4.9% to 3.8% (within a range of 1.3% to 6.2%).
- Due to our significant third-quarter upward revision, we raised our full-year 2020 growth estimate from a decline of 4.9% to a decline of 3.7%. The Blue Chip consensus raised its estimate from a decline of 4.6% to a decline of 4% (within a range of -4.8% to -3.5%).
- Our estimate for first-quarter 2021 growth is 4.6%, which likely will be goosed by additional fiscal stimulus after the election, compared with the Blue Chip consensus of 4% (within a range of 2.1% to 6%).
- We estimate growth in the second-quarter 2021 to be 4.7%, with more stimulus in the pipeline, compared with the Blue Chip consensus of 4% (within a range of 2.2% to 5.8%).
- We think third-quarter 2021 growth will be 2.9%, compared with the Blue Chip consensus of 3.7% (within a range of 2.1% to 5.7%).
- Our fourth-quarter 2021 growth estimate is 2.9%, compared with the Blue Chip consensus of 3.4% (within a range of 2.1% to 5.2%).
- We tweaked our full-year 2021 GDP estimate lower, from 4.6% to 4.5%. The Blue Chip consensus raised its from 3.8% to 3.9% (within a range of 2.8% to 5.1%).