The Small Hint Embedded in Q3 GDP’s Huge Rise

The results are in: US GDP jumped 33.1% annualized in Q3, retracing about two-thirds of the winter and early spring’s COVID lockdown-related decline.^[i] But stocks look forward, and many now argue the future they are looking to is dim: That COVID’s resurgence means lockdowns will return, slowing or even reversing GDP growth—especially if Congress doesn’t pass further assistance measures. We aren’t arguing the road from here will be obstacle-free, and simple math and common sense dictate GDP growth is overwhelmingly likely to slow. But in our view, the largely dour reaction to today’s GDP figures likely helps sap surprise power if things do weaken from here—a plus for markets.

There are plenty of highlights in the report, including imports’ near-doubling—a sign of a solid recovery in business and consumer demand—and business investment clawing its way back with 20.3% annualized growth.^[ii] But in our view, a look at consumer spending, disposable income and the savings rate sheds the most light on today’s big fear. Consumer spending leapt 40.7% annualized, landing just -2.5% below Q4 2019’s peak.^[iii] But services—consumer spending’s largest segment—didn’t rebound as much. Durable goods spending skyrocketed 82.2% annualized, propelling goods expenditures to new highs.^[iv]

This is all the more interesting when you consider people splashed out on big-ticket items even as disposable personal income fell -13.2% annualized, which the BEA’s press release stated “... was more than accounted for by a decrease in personal current transfer receipts (notably, government social benefits related to pandemic relief programs).”^[v] Now, ever since the CARES Act’s supplemental unemployment assistance expired on July 31—which August’s executive order only partially replaced—pundits have warned people would burn through their savings and consumer spending would plunge unless Congress ponied up again. A surge in big-ticket spending alongside lower benefits cuts against that, particularly with the quarter’s savings rate clocking in at 15.8%—down from 25.7% in Q2, but still more than double the pre-pandemic rate.^[vi] Household finances seem to be in far better shape than most headlines allege.

Yes, with some COVID restrictions emerging in some US cities, it is fair to presume the economy probably won’t be as open in Q4 as it was in Q3. As we discussed, Chicago and Newark renewed partial lockdowns Wednesday, and Denver imposed new restrictions Thursday. More may follow. Less economic activity in major metropolitan areas will probably have some impact on GDP this quarter. But beware overstating the impact, which could lead you to suboptimal investment decisions. So far, new restrictions aren’t shutting businesses across the board. Rather, they consist mostly of indoor capacity limitations and curfews. Plus, unlike winter and spring, businesses have had time to anticipate new restrictions and adapt—from adding online ordering systems, curbside pickup and at-home delivery options to moving venues outdoors. We wouldn’t be surprised if such prep-work were partly responsible for business investment’s big rebound.

Absent a full-fledged, global lockdown—which would take a number of political decisions that defy forecasting—we think the most likely outcome is continued recovery. It probably won’t move in a straight line, but that isn’t unique to 2020. In our view, that makes it critical to remember that stocks aren’t GDP, and the two don’t move in lockstep. Stocks reflect publicly traded companies’ likely earnings over the next 3 – 30 months, and they move most on the gap between reality and expectations. GDP, by contrast, is a backward-looking calculation of all economic activity, including small businesses and self-employed people, and it has some calculation quirks that don’t square with the stock market (e.g., counting all government spending as universally positive and ignoring the influence of imports on corporations’ bottom lines). Sentiment surrounding GDP reports can color investors’ expectations, but that is about the extent of the relationship, in our view.

So monitor the risk of second lockdown, which could sow panic and hurt stocks. But don’t dwell on possibilities. Instead, think like markets, and consider whether prevailing pessimistic views reflect the likely reality—not just in the current or next quarter, but in the next year, two or three.