By: Santo Torcivia
For the last several years, the U.S. economy has enjoyed enviable growth and strength, and at the beginning of 2020, its progress seemed unassailable. Housing construction and existing home sales were growing, unemployment was at record low levels, and personal income and business profits were on the rise. Federal regulations were being dismantled, and the U.S. economy seemed to be unleashed and on a strong course. This was before the advent of the worldwide COVID-19 pandemic.
For the first time in history, the U.S. turned off a large portion of its economy to fight a global pandemic (COVID-19), and it did it in conjunction with most of the industrialized world. The federal government declared the pandemic a national emergency, and individual state governors declared some industries essential and many others nonessential. Essential industries like hospitals, food producers, transport firms, and the like were allowed to remain open and function under certain medical guidelines designed to thwart the spread of the virus. All other industries were forced to close temporarily. Individuals were asked to shelter-in-place, and many firms instituted work-from-home policies from March through early June of this year. Beginning in June, some businesses in some states were allowed to open, and restrictions relaxed. This is all new, uncharted territory for businesses and the economy, and lacks any previous precedents. What we know so far as it pertains to the U.S. economy currently and the implications of this unique economic situation:
• Closing “nonessential” businesses and the ripple effects of this action was like shutting down about 25 percent of the U.S. economy, given estimated business revenue and consumer spending lost to Gross Domestic Product (GDP).
• Unemployment rose to 14.7 percent in April 2020, with 23 million people out of work; however, in a surprisingly positive move, unemployment in May fell dramatically to 13 percent as 2.3 million Americans returned to work.
• Bankruptcies and closures among retail stores, restaurants, theaters, and other firms have risen significantly. Thus far, in 2020, there have been more than 9,300 announced store closures (an annual record), and it is estimated by year-end 2020 there will have been 15,000 store locations closed.
• Unlike previous recessions, this one is not a financial collapse. The banks and financial institutions largely remain strong, and the Federal Reserve System has pumped trillions of dollars of liquidity into the financial sector and directly to businesses. Normally, such deficit spending as this causes a currency to collapse and inflation to markedly rise, but the U.S. economy is the world’s strongest, so the U.S. dollar is safe, and inflation likely will remain tolerable.
• The U.S. Department of the Treasury has provided individuals with cash payments of $1,200 per person, and grants have been made to small businesses to maintain employees through the pandemic. Also, low-interest loans (at 3.5 percent APR) are being offered to small businesses to bridge any difficulties resulting from government pandemic mandates, and major corporations are being offered low-rate loans with their common stock as collateral.
• The construction sector has been unaffected largely by the pandemic’s financial aspects, though some states had seen fit to close activity in this sector.
• Work-at-home scenarios will likely extend beyond the pandemic period for some businesses as it reduces company facility costs and employee commuting and travel expenses.
• Given we are still in the midst of the current storm, it is difficult to discern what direction conditions will take. Positive aspects of the current economic situation and assumptions regarding the key drivers of the U.S. economy going forward include:
- The financial sector remains solid and should help businesses bridge over this trying economic situation as the economy and businesses roll open and new firms start-up to fill the void left by closed or defunct firms.
- Although unemployment at present (June 2020) is extremely high, as businesses re-open, this rate is expected to decline quickly as the massive federal stimuli have maintained many firms and their employees financially through the crisis. Due to business closures and changes in consumer habits, it is expected that pre-pandemic employment levels likely will not be reached until 2022.
- It is expected that individuals will gradually resume activities such as visiting restaurants, visiting houses of worship, flying in airplanes and riding public transport, attending sporting events and concerts, etc., and that by year-end, such activities will be back close-to-normal participation levels. This is based on the assumption that people will not see a major spike in COVID-19 cases during the second half of this year, and that broad mitigation policies are no longer required or considered effective against this virus given its known characteristics
- Federal spending for COVID-19 relief and economic stimulus programs has amounted to $2.4 trillion thus far in 2020, and this is in addition to the $4.8 trillion federal fiscal 2020 budget previously approved. Combing these spending programs, netted against anticipated federal revenues of $3.9 trillion, the federal deficit will grow $3.3 trillion this year and the cumulative national debt will grow to $25 trillion or 115 percent of U.S. GDP (in current dollar value). Normally, this would cause inflation to rise significantly and the U.S. dollar exchange rate value to fall. However, mitigating these situations is the fact that compared to all other currencies of industrialized nations, the U.S. dollar and U.S. economy are in much better shape, so the U.S. dollar will not be affected markedly. Also, any significant jump in inflation is offset partly by productivity gains and competitive price pressures as the economy rises out of the current recession. Inflation therefore will remain manageable. Even so, consumer prices in 2022 and beyond will rise around 5 percent.
- Although real consumer spending is down, personal savings rates are up, which bodes well for future spending.
- Although existing-home sales will fall to 3.5 million units in 2020 due to the uncertainties surrounding the pandemic, sales will see a marked recovery in 2021, and will stay on a recovery track through the forecast period (around 5 million units or more) as consumers take advantage of lower prices during and after the current recession. Existing home sales bode well for residential remodeling as consumers refit a home just prior to selling a home and just after buying an existing home.
- Housing construction will see lower volumes in 2020 but will experience moderate growth from 2021 through 2025, averaging more than 1.3 million units annually. Even better is that housing construction throughout the period will be skewed to single-family housing units, which tend to possess significantly more average floor area (2,500 SF/unit) than multi-family units (1,350 SF/unit).
- Non-residential building rehabilitation will not see growth until 2022 as corporate profits revive in 2021 after two years of weak earnings, and firms evaluate what their true requirements will be for space, workers, and enhanced productivity. Of course, this situation will vary by building type with health care and public buildings moving faster to upgrade their facilities and lodgings slowest, as tourism and travel recover more slowly.
- Nonresidential building construction will find similar market dynamics as nonresidential building rehabilitation. Although public building construction will see the most growth, office construction will see the least growth during the period as firms study work-at-home experiences.
- Low energy costs and lower global economic activity will restrain raw material and production prices, and prices in general.
- The U.S. – China trade war and the subsequent tariffs on Chinese imports to the U.S. (plus U.S. exports to China) are forecasted to continue at least through 2022, and likely throughout the forecast period.
- More foreign firms will establish flooring manufacturing operations in the U.S., given domestic production and inventory advantages, tariff avoidance, and rising labor costs abroad.
There are many downside risks related to this forecast, many more than normal. The risks mostly are related to COVID-19 and associated policies, the unprecedented nature of these events, and the impact on the U.S. economy of the virus and subsequent policies implemented to fight the spread of the virus. Some of the most important risks include:
- Consumers do not return to normal, pre-virus patterns as quickly as forecasted, prolonging the economic recession, and/or causing a depression as economic activity languishes.
- Fewer firms reopen for business than predicted, exacerbating unemployment, prolonging the economic recession, and/or driving the economy into a depression.
- Federal and state governments closing a major portion of the U.S. economy and shuttering many persons in their homes to fight the spread of the pandemic is unique and without precedent. As such, there is no historical context to provide any guidance for econometric or market models to accurately predict the economic or market outcomes of such actions. Miscalculations resulting from such unprecedented events are quite likely.
- No new taxes that could stymie consumer spending or corporate investment are expected, and no major shifts in tax policy, industry nationalization, wealth redistribution, or other significant changes to the structure of current U.S. business or social policies are foreseen.
- The significant and fast-growing federal budget deficit is assumed to not cause moderate inflation, but not collapse the U.S. dollar. This factor presents a major risk to the health and stability of the U.S. economy if found to be wrong.
- Although the U.S. stock market remains strong, a risk to this analysis is that a major downturn in the market could trigger a major decline in the U.S. economy.
The GDP (shown in Figure 1), represents the inflation-adjusted, constant dollar value of all goods and services produced in the U.S. per year, and the number of total annual housing starts per year. Given that housing and the industries related to it are the second most pervasive in the U.S. (behind automobile production), it is no wonder that it tracks closely with the movement of GDP.
The COVID-19 pandemic and its related mitigation policies have significantly driven unemployment to levels not seen since the Great Depression (Figure 2) and greatly diminished real consumer spending (Figure 3) as individuals cut spending to weather the situation and the current uncertainty.
Nonresidential construction, and for that matter nonresidential replacement, is linked closely to corporate pretax profits and business investment in structures.
As profits rise, employment, construction, and investment in structures increases (Figure 4). Given the economic uncertainty, nonresidential investment in structures will not grow until 2022 once profits have returned and the situation with the virus, the economy, and their particular business segment, becomes clearer (Figure 5).