We finally received the first estimate of second-quarter GDP this week, along with a bunch of other data. Though the figure wasn’t quite as bad as the consensus estimate of -34.5%, the economy still shrank at an annualized rate of 32.9% compared to the first quarter of the year. The contraction took inflation-adjusted GDP back to a level last seen in the fourth quarter of 2014, effectively nullifying six and a half years of growth. The biggest driver of the decrease was consumer spending, which typically accounts for about 68%-69% of total GDP and also came in at levels not seen since 2014.
Private investment, which has accounted for about 17%-18% of GDP in recent years, also came in at multi-year lows. The last time we saw private investment (adjusted for inflation) this low was in the second quarter of 2013. If we take out the contribution from residential investment, which yields a proxy for business investment, we also haven’t seen these levels since 2013.
The third major component of GDP (we’re leaving out net exports due to its small relative importance) is government spending. As you might expect, government spending is coming in at record highs. This makes sense because the government is expected to fill the demand void that accompanies recessions.
You might be asking yourself why government spending didn’t rise more than it did. Isn’t the federal government running up trillions in debt to support businesses and consumers reeling from the effects of COVID-19? The answer is yes, but that money doesn’t show up in the GDP figures until it is spent. The chart below shows that personal transfer receipts, which include unemployment benefits and the stimulus checks that were sent out to individuals, spiked by $2.4 trillion (annualized) in the second quarter to $5.6 trillion (annualized). Transfer payments rose so much that they accounted for about 28% of personal income in the quarter compared to a recent average of around 18%.
The problem for the economy in the second quarter was that consumers were reluctant to spend those transfer payments. The last chart below shows that personal savings rose by $3.1 trillion (annualized) in the second quarter, which was a bigger increase than the sequential increase in transfer payments of $2.4 trillion. The savings rate, which is personal savings divided by disposable personal income, rose to almost 26% in the quarter from a recent average of around 6%-8%. It was this unwillingness on the part of the consumer to spend the government windfall that accounted for the lion’s share of the economic contraction in the quarter.
The good news is that consumers started to open up the purse strings a bit more in the latter half of the second quarter. Personal spending and retail sales for May and June were quite promising. However, a more recent second wave (or, more accurately, a flair up from the first wave) of COVID-19 in July may have caused a setback to consumer confidence. Consumers may also be concerned that Congress won’t reach a compromise on another round of economic support. If these things aren’t resolved relatively quickly, the consumer could easily crawl back into his shell and stop spending again. But our money is on the optimistic outcome given the huge importance of economic stability in an election year. The consumer may be down, but he’s certainly not out.
We’ve opined that a V-shape economic recovery is probably not in the cards. If that assumption indeed comes to fruition, it will be very important to own high-quality, financially strong companies with great management teams. These are the types of companies we favor at Farr, Miller & Washington.