Our Economy Shrank By 5% in the First Quarter

Economy

On May 28th, the Commerce Department reported that our U.S. economy shrank at an even faster pace than previously estimated in the first quarter of 2020 and consensus expectations are that the second quarter of 2020 will be far worse.

Gross domestic product – often considered the broadest measure of our country’s economic health – fell at an annual rate of 5% in the first three months of the year, revised two-tenths upwards from the estimate given just a month ago.

That 5% decline is the largest quarterly decline since the fourth quarter of 2008, when our GDP fell 8.4%.

GDP – A Very Complete Picture

The Commerce Department’s Bureau of Economic Analysis compiles the GDP report monthly and it is one of the most closely-watched reports on our economy given how much economic information it contains. Percent change from prededing quarter Not only does the GDP report provide detailed data on how our economy is performing, but it also provides data that can help investors identify certain trends going forward. Broadly speaking, there are four main components of the GDP report, including:

  1. Personal consumption;
  2. Business investment;
  3. Government spending; and
  4. Net exports.

The data from the BEA’s GDP report includes a wealth of information, including details on how much we spend and on what, inflation indices, corporate profits and details on imports and exports.

As such, all investors should heed GDP numbers because the data paints a very good picture of the economic backdrop for both equity and fixed-income markets alike, which of course helps inform the performance of their portfolios.

Reasons for the Decline in GDP

Unless you’ve been living under a rock, you know the reason behind the drop in our GDP: COVID-19. In fact, this is taken directly from the GDP release:

“The decline in first quarter GDP reflected the response to the spread of COVID-19, as governments issued "stay-at-home" orders in March. This led to rapid changes in demand, as businesses and schools switched to remote work or canceled operations, and consumers canceled, restricted, or redirected their spending. The full economic effects of the COVID-19 pandemic cannot be quantified in the GDP estimate for the first quarter of 2020 because the impacts are generally embedded in source data and cannot be separately identified.”

Second Quarter Will Be Much Worse

It is generally accepted that GDP will sink further in the second quarter of 2020, when the impact of shutdowns and layoffs are felt more dramatically.

Currently, many economic models are predicting that GDP will sink to an annual rate of more than 50% in the second quarter, which would be the biggest quarterly decline on record and a whopping 5-times greater than the previous record set more than 60 years ago in 1958. Remember, even during the worst times of the 2008/2009 Great Recession, the worst contraction in GDP was just 8.4% in the fourth quarter of 2008

As a point of reference, consider the model called GDPNow that is published by the Federal Reserve Bank of Atlanta (which they are quick to point out is not an official forecast of the Atlanta Fed or a forecasting model). According to the Atlanta Fed, GDPNow is a “nowcast” that is “best viewed as a running estimate of real GDP growth based on available data for the current measured quarter.”

The latest GDPNow model from June 1st estimates that real GDP growth in the second quarter of 2020 will be -52.8%. That is down from -51.2% on May 29th. 

But before you think that the sky is falling, consider that in big, bold and very red letters, the Atlanta Fed adds this disclaimer:

“In particular, it does not capture the impact of COVID-19 beyond its impact on GDP source data and relevant economic reports that have already been released. It does not anticipate the impact of COVID-19 on forthcoming economic reports beyond the standard internal dynamics of the model.”

So, will GDP drop more than 50% in the second quarter of 2020? Impossible to predict. But even Federal Reserve Chair Jerome Powell said that second quarter GDP could “easily be in the 20s or 30s” before recovering in the second half of the year.

Predictions Beyond 2Q2020

It would of course be wonderful if we could just apply Newton’s third law to GDP predictions for the third quarter of 2020 and beyond.

In case you don’t remember, Newton's third law is: For every action, there is an equal and opposite reaction. But that’s just not how it works.

Nonetheless, consider how fast these GDP numbers have fallen from the fourth quarter of 2019 (+2.1%) to the first quarter of 2020 (-5.0%) to whatever the second quarter of 2020 will be (a big minus number).

While there are a lot of variables of course, principally with respect to how long it will take businesses to reopen, how quickly jobs are brought back, and how much we spend (consumer spending is about 2/3 of GDP by the way), many are forecasting that the third quarter will see a sharp spike in GDP.

In fact, the Congressional Budget Office predicted GDP will rise at an annual rate of 21.5% for the third quarter of 2020, a number that will undoubtedly move around as more data comes in.

What Should Investors Do?

Of course there is no single answer that will provide direction for everyone and investors should only make changes to their portfolio based on their personal circumstances.

If you are considering changing your asset allocation, ask yourself the right questions, including:

  • What are my goals?
  • What is my tolerance for risk?
  • What is my time horizon?

Your financial advisor is a great sounding board to help frame these topics, ask more insightful questions, and ultimately create a financial plan that is right for you and your family.

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