Economic pulse check
It’s been roughly a year since the pandemic derailed economies and financial markets across the globe. With the major US stock indexes hovering near record highs, it may seem like the market has all but put the coronavirus behind it. But it’s important to remember that the market is not the economy—and economic indicators are telling a more nuanced recovery story to which investors may want to lend an ear.
While market watchers may sometimes overlook these indicators, economic data is closely watched by the Fed and Congress—arguably two of the larger market movers in modern history. In the coming months, these policymakers will be evaluating another trillion-dollar relief package and determining whether to adjust an ultra-accommodative monetary policy—decisions that will undoubtedly factor into market performance this year.
Gross domestic product (GDP)
Following Q2’s record-setting 31.4% contraction and Q3’s historic 33.4% expansion, the latest GDP reading showed the US economy grew by 4% in Q4 2020 and declined 3.5% for the full year.1 Looking ahead, the Federal Reserve expects GDP to grow 4.2% in 2021,2 with economists at Morgan Stanley forecasting a more optimistic 6.5% growth rate this year.3
Unemployment was at a half-century low of 3.5% before the pandemic wiped out millions of jobs. After spiking to 14.8% last April, the jobless rate now sits at 6.3%.4 The Fed expects the rate will fall as low as 5% this year,2 but cautioned that the job recovery has moderated in recent months, and many sectors like leisure and hospitality are still exceptionally weak.5
Although the Consumer Price Index (CPI) is probably the best-known inflation gauge, the Fed prefers to reference the Personal Consumption Expenditures (PCE) price index for its policy decisions. While inflation is currently well below the Fed’s 2% target (and has been for the better part of the past decade), some analysts expect it to pick up this year in the aftermath of unprecedented stimulus measures.
After rebounding strongly in May and June, consumer spending slumped toward the end of 2020. While the personal savings rate is still elevated compared to historical levels, it’s come down significantly from its peak in April.6 Economists expect that cushioned savings and the latest round of stimulus checks, as well as pent-up demand, may spur spending as the virus subsides. January’s retail sales numbers were a promising sign that consumers may be ready to open their wallets—sales surged 5.3%, and every major spending category saw gains.7 Considering the consumer drives roughly 70% of GDP, the more consumers spend, the stronger the economic recovery may be.
While observers have debated whether there’s excessive exuberance in the stock market, the economy is showing solid, measured progress. Meanwhile, COVID cases have declined, vaccines are becoming more available, and policymakers appear committed to doubling down on support measures.
For intrepid investors, the economic indicators we just walked through also present some near-term considerations:
- Low rates have been a boon for the housing market: Housing has been one of the hottest parts of the US economy amid the pandemic, and the outlook for 2021 remains strong. A robust housing market may factor into solid performance among related areas such as homebuilders, real estate developers, listing agencies, and home-improvement companies.
- Growth forecasts abroad are bullish: Analysts at Morgan Stanley believe a case can be made for emerging market equities outperforming US stocks. Evidence that China’s economy is continuing to rebound strongly (GDP actually grew in 2020 and analysts forecast 9% growth in 20218) may fuel growth in emerging market countries, especially in Asia.
- Steeper yield curve, strong consumer may boost financials: After years of underperformance, financial stocks have outpaced the broader market over the past few months. The sector is benefiting from trends that may continue, including a steeper yield curve and strong consumer and corporate balance sheets. Valuations remain attractive, although they've risen considerably since the fall.
One point to keep in mind: We are still in the early stages of the economic recovery, where bouts of volatility should be expected. Investors should keep their eyes set on the horizon and portfolios aligned with individual timelines, long-term goals, and risk tolerance.
- US Bureau of Economic Analysis, Gross Domestic Product, Fourth Quarter and Year 2020 (Advance Estimate), 1/28/21, https://www.bea.gov/sites/default/files/2021-01/gdp4q20_adv.pdf
- The Federal Reserve, Summary of Economic Projections, 12/16/20, https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20201216.pdf
- Morgan Stanley Research, “2021 Investor Strategy Outlook: Six Takeaways for the Year Ahead,” 12/1/20, https://www.morganstanley.com/ideas/global-investment-strategy-outlook-2021, Note: Morgan Stanley raised its 2021 US GDP forecast to 6.5% on January 29, 2021.
- US Bureau of Labor Statistics, Employment Situation, 2/5/21, https://www.bls.gov/news.release/empsit.htm
- CNBC, “Federal Reserve leaves interest rates and asset purchases unchanged, sees growth slowing,” 1/27/21, https://www.cnbc.com/2021/01/27/fed-decision-january-2021-rates-unchanged.html
- MarketWatch, “Consumer spending slumps at the end of 2020 and bogs down economic recovery,” 1/29/21, https://www.marketwatch.com/story/consumer-spending-slumps-at-the-end-of-2020-and-bogs-down-economic-recovery-11611928007
- CNBC, “Retail sales burst higher in January as consumers use stimulus checks to spend heavily,” 2/17/21, https://www.cnbc.com/2021/02/17/us-retail-sales-january-2021.html
- Morgan Stanley Wealth Management, “5 Reasons Why Emerging Markets May Just Be Getting Started,” 1/25/21, https://www.morganstanley.com/ideas/emerging-markets