FINANCIAL MARKET UPDATE 8.4.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

BREAKING DOWN THE GDP REPORT

Economic data dominated headlines last week following the report of Gross Domestic Product (GDP) for the second quarter. The figure, which showed economic activity declined by an annualized 32.9%, was reported as the worst on record. While the number is undoubtedly awful, it is likely somewhat overstating the depth of decline, and there are emerging signs that activity has already begun to rebound. Before we go there, let’s begin with a little bit of background. 

 

What is GDP?

GDP measures the total value of all goods and services produced in a country within a specific period of time. The data provides an assessment of the overall size and health of the economy and is the gold standard for measuring growth. GDP is calculated by the Bureau of Economic Analysis (BEA) and is published quarterly.

There are four major components used to calculate GDP:  GDP = C + I + G + (X-M)

Consumer spending typically comprises about 2/3rds of the figure, which is why consumer sentiment data is so widely followed. Given the U.S. has consistently run a trade deficit over the years (imports have exceeded exports), the trade balance component has generally been a drag on GDP.

Q2 Data

The 32.9% annualized decline in GDP during the second quarter is by far the steepest drop since record-keeping began in the 1940s. For comparison purposes, the first quarter of 1958 saw the next largest decline of 10.0%. The worst data print during the Great Recession was the fourth quarter of 2008, which saw an 8.4% decline. Last week’s report follows an annualized decline of 5.0% Q1. Two consecutive quarters of negative GDP is traditionally what signals the economy has entered into a recession. The decline in economic activity and the spike in unemployment since February was so dramatic. However, authorities did not wait for the GDP data to declare that a recession had begun.

The fall in Q2 came from a collapse in consumer spending and private investment caused by lockdowns and social distancing measures. Increases in federal government spending offset declines at the state and local levels, while the level of imports declined faster than exports, each of which made small positive contributions to the figure. 

Source: BEA

Where We Go From Here

As I mentioned at the start, the GDP decline has likely been overstated, arising from the fact that the data has been annualized. Annualizing assumes that the next three quarters will be identical to the last. This is most likely an unreasonable assumption, as much of the country was in full lockdown mode for a meaningful portion of the quarter. The non-annualized GDP figure reflects a much lower 9.5% decline in economic activity.

A surge in COVID-19 cases that began in early June has caused some states to roll back some easing of restrictions. Recently, there has been evidence the overall spread has begun to slow, and the level of economic activity has continued to be much higher than in prior months. Many economists are anticipating a return to growth in Q3. The Federal Reserve Bank of Atlanta publishes a widely followed real-time estimate of GDP (GDPNow), which is currently forecasting annualized Q3 GDP at 19.6%. Again, annualizing the data will overstate the degree of change. Some portion of the growth likely represents pent-up demand from when the economy was locked down, so the initial pace of recovery will likely moderate. Still, the return to growth would be a welcomed occurrence and would make this recession one of the shortest (albeit deepest) on record.

WEEK IN REVIEW

  • Last week the Federal Reserve announced the decision to hold interest rates steady at 0.00-0.25% following the conclusion of its Federal Open Market Committee (FOMC) meeting (as expected). It also reiterated its intention to maintain its bond purchase and other lending programs it had enacted to restore proper market functioning. At the post-meeting press conference, Fed Chair Jerome Powell reiterated the view that “the path of the economy will depend significantly on the course of the virus.”
  • The Institute for Supply Management (ISM) published its manufacturing index at the beginning of the week, which climbed to a 15-month high of 54.2%. The index generally reflects the rate of change in activity and not the actual level. As a result, it appears the manufacturing sector is improving but remains at a much lower overall level than it did before the pandemic. Later this week, we will get ISM’s non-manufacturing index (Wednesday), initial & continuing jobless claims (Thursday), and headlining the week of economic data will be the jobs report (Friday).
  • 63% of the companies in the S&P 500 have reported earnings for the second quarter. If you blend the earnings growth rate of the companies that have already reported, with the estimates from the companies that have yet to report, Q2 earnings growth is currently -35.7%. This represents an improvement over the -44.1% expected at the beginning of the quarter. Reports published last Thursday showed Apple, Facebook, Amazon, and Alphabet all beat earnings estimates, which contributed to the improved blended earnings growth rate.

HOT READS

Markets

  • Fed Holds Rates Steady, Says Economic Growth is ‘Well Below’ Pre-Pandemic Level (CNBC)
  • Covid Supercharges Federal Reserve as Backup Lender to the World (WSJ)
  • High Frequency Indicators for the Economy (Calculated Risk)

Investing

  • Does a Mutual Fund’s Past Performance Predict Its Future? (Yale Insights)
  • Big Tech Faithful Shouldn’t Ignore Antitrust Risk (Bloomberg)

Other

  • How Tech is Packing Empty Stadiums with (Fake) Raucous Crowds (Protocol)
  • Covid-19 Prompted Purdue University to Shut Its MBA Program. More Closures Are Expected. (WSJ)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY