By: Montana Timpson
Economist Mark Schug, Ph.D., Professor Emeritus at the University of Wisconsin-Milwaukee, joined Lightspeed last month to present a live webinar recapping the year’s fiscal performance to date and its implications for the rest of 2021.
Detailed insights included market predictions regarding specific touchpoints like recent GDP performance, recent relief legislation, federal spending, national debt and future inflation, changes to corporate income tax, economic policy uncertainty and analyst predictions regarding the performance of the DJIA and the S&P 500.
Consumption, investments, government spending and net exports all factor into the U.S. gross domestic product (GDP) valuation. According to Dr. Schug, the real GDP increased at an annual rate of 6.4% in the first quarter of 2021, according to the advance estimate released by the Bureau of Economic Analysis. The increase reflected the continued economic recovery largely driven by the reopening of businesses.
In the first quarter, government assistance payments were distributed to households and businesses including direct economic impact payments, expanded unemployment benefits and Paycheck Protection. Additional government programs included the Coronavirus Response and Relief Supplemental Appropriations Act, the American Rescue Plan Act and the Coronavirus Response and Relief Supplemental Appropriations Act.
Dr. Schug posed that the increase in real GDP was mainly driven by personal consumption expenditures, business spending with businesses building up inventory. Increases in spending on durable goods like cars and trucks as well as food and beverage and services were noted, as well.
Factors Suggesting Stronger Economic Growth in the Second Half of 2021
Most GDP forecasts suggest that the economy will continue to grow in 2021, as housing and manufacturing continue to be strong and interest rates remain relatively low.
While the housing market, in particular, suffered a significant hit due to the pandemic, it has rebounded as potential home buyers regain confidence. Homes are being viewed as more important today and higher net worth people are seeking more space. The NAHB Housing Market Index, a measure of home building activity, ended steady in May despite some supply side issues with framing and lumber prices.
The Institute for Supply Management reported manufacturing grew in May 2021. Still regarded as healthy. As Dr. Schug reminded viewers, “Anything above 50 is regarded as good.”
An economic forecasters panel surveyed by the Philadelphia Fed predicts real GDP will grow at an annual rate of 7.9% this quarter, up 2.9 percentage points from the prediction in the last survey. Over the next three quarters, the panelists also see a stronger rebound in output growth than they predicted previously.
Economists at Wells Fargo are forecasting full-year GDP growth to come in at 7.0%, which would mark the second-fastest year for growth since 1955 (full-year growth in 1984 was 7.2%).
They also point out that it is increasingly evident that the fastest pace of expansion in decades comes with some significant growing pains.
The Economic Uncertainty Index looks to confirm the positive sentiments, with the index declining considerably with the reopening of the economy. As economic uncertainty is usually associated with declining stock markets, a decline in the Economic Uncertainty Index is good news for investors.
However, there are numerous variables that drive the economy, and Dr. Schug warned to take all forecasts with a grain of salt, going so far as to wonder if confirmation bias is possible when all the forecasts seem to be saying the same thing.
Factors Suggesting Weaker Economic Growth in the Second Half of 2021
Factors that suggest weaker economic growth in the second half of 2021 include inflation, CPI metrics, government policies and national debt.
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The CPI is compiled by the Bureau of Labor Statistics (BLS). The CPI reports a price index of a market basket of 300 items. That “basket” includes food and beverage, housing, apparel, transportation, medical care, education and communication, recreation and more. The Consumer Price Index increased 5.0% in May, the largest increase since August of 2008.
“To stimulate economic growth, the Fed is keeping interest rates very low. The Fed is also buying $80 billion in Treasuries and $40 billion in MBS each month,” explained Dr. Schug.
Inflation and the National Debt
If inflation continues, the government will need to raise interest rates. On June 18th, the government hinted that it might start raising rates as soon as late 2022.
The Congressional Budget Office (CBO) expects interest rates to stay below historical levels for at least a decade, projecting that the average interest rate on Treasury securities will drop from 2% in 2020 to 1.3% in 2023 through 2025 before rising to 2.4% by 2031. However, a rise in inflation rates could greatly aggravate this forecast.
How Might the Markets Perform in the Second Half of 2021?
Most Wall Street analysts are optimistic about stocks. “These folks are looking at strong GDP growth, consumer spending, and low interest rates,” said Dr. Schug.
RBC Capital Markets slightly upgraded its outlook on S&P 500 earnings, citing a stronger outlook for corporate profits this year. Deutsche Bank predicts more upside for equities due to the rebound from the pandemic. Goldman Sachs raised its S&P 500 earnings outlook due to higher corporate and rebound from the pandemic.
Concerns about the pandemic have eased but the economy is not fully open so there is room to grow. Corporate earnings have exceeded expectations and shortages of some products and materials may spur more investment. Sectors expected to see the most action include manufacturing, energy, oil, steel and travel, whereas last year, stock pickers flooded into tech stocks that they thought would benefit from the pandemic.
In conclusion, Dr. Schug suggested that overall, the economy has performed well so far in 2021.
Economic forecasters are predicting that the economy will continue to grow, and housing and manufacturing look strong. Policy uncertainty is declining, and the biggest fear is inflation which might cause the Fed to raise interest rates sooner rather than later. All in, investors appear upbeat for 2021.
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