Q2 GDPs Were Historically Awful, but Not a Surprise

Q2 GDP results for the first two major developed nations to report emerged today, and in a word, they are … ugly. The US and Germany each notched record-fast declines, and they probably won’t be the last to do so. As these awful Q2 numbers hit the wires, we think it is worth remembering stocks spent February and March reckoning with the lost activity that is now registering in GDP—and markets are now looking far, far beyond what happened between April and June.

Perhaps the most surprising development is that US GDP didn’t fall quite as much as German. US output fell -32.9% annualized, which translates to -9.5% q/q.^[i] German GDP fell -10.1% q/q, which simple math translates to -34.7% annualized.^[ii] We did this math because the US’s Bureau of Economic Analysis’s headline figure is the annualized rate, which is the rate GDP would fall over an entire year if the quarter-over-quarter rate persisted for four quarters. But Germany, like the rest of Europe, uses the quarter-over-quarter figure. The math makes it easier to do a comparison.

Considering Germany began reopening from the COVID lockdowns before most of the US, it would be reasonable to expect German GDP to fall less than the US’s. Analysts certainly did. According to FactSet’s most recent surveys, consensus estimates were for German GDP to drop -9.0% q/q, beating the US, which analysts estimated at -10.1% q/q (based on consensus estimates of a -34.6% annualized drop).^[iii] Germany’s initial release doesn’t include a detailed breakdown, though the presser noted a “massive slump” in trade and private demand, with only government spending increasing. The US breakdown showed much the same. But we won’t know for a few weeks whether the US’s edge over Germany stemmed from a slightly less bad private sector decline or relatively higher government spending—presuming that edge isn’t revised away in future releases.

Not that it matters. For one, stocks don’t move one to one with GDP. Two, tempting as it may be to dig into the details to see which country’s COVID response had less of an economic impact, that is useful only for academic purposes—not portfolio positioning or stock market forecasting. Based on how markets normally behave, we think the bear market that ran from February to March 23 was stocks’ way of pre-pricing the recession that the data are now registering. Stocks pretty much always lead the economy, with bear markets starting months before recessions do. During a bear market’s panicky throes, they generally look to the short end of their typical 3 – 30 month horizon, focused exclusively on the near-term damage. A bear market is stocks’ way of reckoning with an economic contraction and its effect on corporate earnings. Once markets have a reasonable idea of how deep the recession will be and how long it will last, they are able to start looking further out and weighing how the recovery will help earnings recover over the next couple of years. We think that is what they have been doing since late March and continue doing today.

We also think that long-term view is entirely rational. GDP is a useful, comprehensive look at all economic activity. But because it is quarterly (outside the UK and Canada), it glosses over month-to-month changes. In this case, it glosses over the stark improvement most monthly metrics showed in June, as more businesses began reopening. Retail sales and industrial production surged in the US and Germany in June. As we covered earlier today, flash purchasing managers’ indexes suggest the recovery continued in July. Analysts now expect US GDP to start recovering in Q3, with an 18.4% annualized rise.^[iv] That isn’t a complete recovery, but it is a fine start. Past bull markets have proven stocks don’t need GDP to recover its prior peak as quickly as it fell. A recovery that puts corporate earnings on a path higher over the next year, two, three or more is enough.

All evidence today suggests this outcome is likely. Even with COVID lingering, countries have avoided new, sweeping national lockdowns. For the global economy, that is really what counts and, barring a reversal, should allow a recovery to unevenly continue from here.