With the recent $1.9 trillion stimulus package now signed into law, more than $5 trillion has been authorized over the past year to combat the economic impact of the COVID-19 pandemic. Like its predecessors, this bill sends checks to households, supports small businesses, extends unemployment insurance, funds healthcare initiatives and more.
Although this spending is not without controversy, the fact that this level of relief has been passed one year after the lockdown began speaks to the long-term impact of the economic shutdown.
That this stimulus spending now is controversial is due to the nature of the recovery – and the ability to provide targeted relief. While the overall economic recovery has been strong and is expected to accelerate throughout 2021, that is not universally the case. This divergence is often referred to as a “K-shaped recovery” in which some sectors – including tech and online retail – have not only bounced back but grown, while sectors at the “epicenter” – like brick-and-mortar retail, restaurants, and travel-related companies – continue to experience challenges.
Although this disparity has clearly impacted stocks, the rotation from those pandemic-resistant sectors to those epicenter companies is happening now. This is in part due to the strong performance of growth and tech sectors over the past twelve months – and the resulting high valuations in those sectors – as well as the re-opening of the economy as vaccines are distributed. Year-to-date, the energy, financial, industrial and basic materials sectors have led the market higher, while information technology and healthcare have been flat. The equal-weighted S&P 500 Index has also outperformed the standard market-weighted index – an indication that gains are broader now than at the start of the recovery.
As it relates to the economic rebound, the latest stimulus package raises three important considerations for investors.
First, many investors are concerned about federal spending over the past year.
During the government’s 2020 fiscal year, the CARES Act pushed the federal deficit to 15% of GDP – even worse than during the 2008 financial crisis, when it reached 10%. In 2021, federal spending will continue to increase – but keep in mind that GDP will also improve, too, helping to keep this ratio in check.
Historically, the deficit jumps in times of crises and then moderates as spending returns to normal and the economy grows. Of course, “normal” over the past 70 years has also involved persistent deficits. So while it’s unclear what the limits on our federal debt will be, it’s also well understood why the government was forced to spend to keep the economy on life support over the past year. The question is really whether there will be political pressure to improve budgetary discipline as the recovery continues.
Second, the stimulus bill will help to support those individuals and households who have been directly hit by the pandemic. However, the average household has been financially strong over this period. Not only did many jobs return quickly, but the stock market increased in value, home prices jumped and savings rates improved. This suggests that many households have a greater cash cushion today than in the past – and that increases the possibility of a further boost to the economy, as consumer confidence and spending improve in the months and quarters to come.
Finally, business activity has recovered remarkably well. By many measures, industrial and manufacturing activity in the U.S. is growing at the fastest pace in 3 years. Job gains have accelerated in recent months and there are now nearly 7 million open positions across the country – not too far from the historic pre-COVID peak. The market has begun to reflect this reversal, too, as manufacturing-related sectors – including ones tied to commodity prices – have surged.
So while there are still many uncertainties surrounding the recovery, the situation has improved dramatically from a year ago. And although the stimulus package is not without controversy due to its size and timing, it’s also clear that many individuals and businesses still need support. Below are a few charts that put this economic picture in context.
1. The federal deficit grew to 15% of GDP in 2020
History shows that the federal budget deficit tends to expand during times of crisis. This was true during the Great Depression, World War II and the global financial crisis. The question is whether spending will moderate once the crisis subsides. In the near-term, while stimulus spending continues, a growing economy will also improve this particular outlook over time.
2. Households are saving more
Household savings have remained high – even as the economy has improved and consumer spending has returned. In the short run, this is a sign that consumers are still cautious. However, it’s also a positive sign for the health of consumer finances – and for possible future increases in consumer spending, too…also a tailwind for economic growth.
3. Economic activity continues to accelerate
Industrial activity continues to accelerate, another good sign for overall economic growth across the country.
The bottom line?
The latest stimulus package should help to cushion many parts of the economy as the recovery continues. In the meantime, long-term investors should continue to focus on the light at the end of the tunnel as markets adjust to this improved outlook.
Please let me know if you have any questions or comments.