April 29, 2020
Executive Summary: The US economy contracted 4.8% in the first quarter, worse than the consensus expectations of -3.9%. Consumer spending dipped in February as activity tapered then collapsed in March due to COVID-19 lockdowns when services were shutdown. The US economy has clearly entered a recessionary phase. As the economy opens up and people are allowed to return to the dentist and go out to dinner, we will begin to see the damage done from the COVID-induced recession begin to mend.

A Review of the Major Categories

Consumer spending declined 7.6%, the largest quarterly drop since the 8.7% decrease during the second quarter of 1980. Total consumer spending fell to $13.1 trillion, a decrease of $260.8 billion quarter over quarter and slicing 5.26 percentage points from overall gross domestic product (GDP).

The shutdown of the trio of healthcare services, restaurants and hotels, comprised 80% of the first quarter decline in headline GDP.
As we would expect given the coronavirus lockdowns, the downshift in spending was clear in big-ticket items (durable goods). However, consumer services were decimated, accounting for 95% of the decline in consumer spending. Healthcare services were the largest detractor, carving off 2.25 percentage points from overall GDP. These include healthcare of all stripes, from wellness and routine visits to primary care physicians along with non-emergency surgeries. Of course, it also includes other procedures, such as dentistry, optometry and ophthalmology, and dermatology, that can have quasi-discretionary timing, as well as elective surgeries. It was followed by restaurants and hotels, which sliced off another 1.61 percentage points from GDP.

Residential construction remained a bright spot, building on prior momentum and persistent tight supply. It increased 21% for the quarter, adding 0.74 percentage points to overall GDP, its largest quarterly contribution since 2004. Much of the housing growth was likely achieved ahead of the lockdowns, although private reports indicate that most existing late-stage building continued, having been deemed essential in most areas. We expect that new housing activity, particularly for multi-family construction, will grind to a halt for the next few quarters.

Business inventories declined $16.3 billion from the quarter, carving off 0.53 percentage points from overall GDP. Not surprisingly, nonfarm inventories shrank sharply, likely due to hobbled supply chains and reduced global production, while farm inventories rose.

Outside of inventories, overall business spending continued to struggle, declining for the fourth straight quarter. It dropped 8.6% in the first quarter and subtracted 1.17 percentage points from overall GDP. Both commercial construction and spending on equipment decreased sharply, down 9.7% and down 15.2%, respectively. Even spending on computer & information processing equipment slipped; however, software purchases propped up spending on Intellectual property products, which rose modestly.

Net exports added an outsized 1.30 percentage points to overall GDP, as imports plunged and exports dipped modestly. Imports decreased by more than $140 billion during the quarter, as imported services collapsed 29.8%, which were obviously impacted by global COVID-19 travel restrictions. Similarly, exported services dropped 21.5%. We note that the net export figures are based on incomplete data at this stage of the process and are known to be revised frequently.

Government spending edged up 0.7%, contributing 0.13 percentage points to overall GDP. Federal spending accounted for the bulk of the increase, while state and local spending was nearly flat quarter over quarter.

Looking Ahead – A Wide Range of Potential Outcomes

Given the tremendous amount of uncertainty, there is a wide range of possible economic results. The current median consensus projects a sharp slowdown, concentrated in the second quarter of 2020, with improvement in the third and fourth quarters. The consensus estimate for the full year 2020 is -3.7%; we anticipate it could be -5.4% as typical recessionary forces take hold and consumer services are shut down for April and May (and annualized).

Bottom Line

The pullback in consumer and business spending accelerated and mushroomed with the lockdowns in March. Ironically, the biggest single detractor from first quarter GDP was healthcare services, which alone accounted for nearly half of the first quarter’s decline in GDP. Together, the shutdown of the trio of healthcare services, restaurants and hotels, comprised 80% of the first quarter decline in headline GDP.

Our outlook remains mixed at this point, although optimistic in the longer term due to the services component of the US economy. On one hand, the unstoppable typical recessionary forces—highlighted by layoffs and restructurings—have begun to damage the US economy and will not easily be undone. Like most recessionary recoveries, the coming recovery will be measured in quarters and years. On the other hand, the massive size of assistance programs by the federal government, with a large income replacement component for individuals and businesses, and the Federal Reserve’s efforts should blunt some of the downside and hasten the eventual recovery.

More importantly, the services component comprises 45% of the US economy. It will take quarters to fully recover from the COVID-19-induced damage, but just being allowed to return to the dentist and go out to dinner will have a surprisingly immediate and large impact on helping mend the economy.

Revisions to first quarter 2020 GDP will be released at 8:30 AM ET on May 28, 2020.

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