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Midyear Outlook: U.S. economy ready to boom, zoom and consume
Darrell Spence
Economist
Hilda Applbaum
Portfolio manager
Chris Buchbinder
Equity Portfolio Manager

COVID clearly remains a global public health threat and continues to spread in many countries. But in the U.S. – as with many other countries across the globe, consumers are spending again, and the American economy is awakening from its artificially induced slumber.


“We are seeing huge pent-up demand and are all likely to underestimate both its magnitude and duration,” says portfolio manager Chris Buchbinder.


“As we've seen in Israel, China and other countries, as you get the virus under control, new cases plummet and activity rises rapidly, so I expect the economic rebound we are seeing in the U.S. to ramp up dramatically.”


Thanks largely to rising consumer spending and trillions in government stimulus, U.S. gross domestic product rose an annualized 6.4% in the first three months of the year, and total U.S. economic output could return to pre-pandemic levels by the end of 2021, years ahead of earlier expectations.


In fact, the International Monetary Fund (IMF) expects 6.4% U.S. GDP growth for all of 2021 — more than double a January estimate of 3.1% after U.S. household income growth soared to a record 21.1% this March.


“The recovery always came down to whether there would be enough stimulus to sustain us through the shutdowns,” says Capital Group U.S. economist Darrell Spence. “And with the vaccine rollout compressing the time between stimulus and the functional end of COVID, we could see even stronger growth than the market expects today.”


Sitting on a cash stash


Indeed, many U.S. consumers — sitting on a cash stash and ready to spend it — have already begun to turbocharge the recovery. Aided by stimulus cheques and a recovering jobs market, personal savings rates soared to 21% of disposable income in the first quarter of 2021. And there are indications that consumers, many of them fully vaccinated, are planning to use some of their cash to take long-delayed holidays or simply get out of the house and go to dinner. Bookings for domestic air travel and reservations placed through online service OpenTable have rebounded strongly.


“Our memories are marked by experiences and connectedness with other human beings, so I think travel and dining out will come roaring back,” says Hilda Applbaum, a portfolio manager “But the market anticipated this. The question is, ‘Have any of these companies become even stronger because of COVID?’”


Many businesses in the travel and leisure industries did not take the pandemic pain standing still. Cruise lines like Royal Caribbean have established strict protocols to limit the spread of illness when sailing resumes. Companies like Hilton are buying more properties and streamlining operations. In food service, Darden, a multi-brand restaurant operator, adopted pickup service, online ordering and contactless payments.


“Some companies have used the crisis to innovate and improve,” Applbaum says. “I try to invest in those that are positioned to surpass the competition when the reopening picks up speed.”


Signs show U.S. consumers are getting out and spending 


Sources: OpenTable, Transportation Security Administration. Airline volume represents number of U.S. passengers screened by TSA and uses 18/2/20 as the pre-COVID baseline. All data uses seven-day smoothed averages.


Established companies adapt to disruption


Given the spectacular gains of relatively new, tech-savvy companies over the past decade, it’s understandable when those high flyers dominate the headlines. But investors shouldn’t forget about old guard companies with the resources to compete and the drive to learn from their upstart competition.


Examples are everywhere. Retailers like Target, Costco and Home Depot are ramping up their digital operations to take on Amazon. And General Motors and Volkswagen are challenging Tesla in electric vehicles.


“One investment theme that will be interesting to watch this year is whether the empire strikes back — whether these legacy companies can innovate and execute in a fiercely competitive environment,” says equity portfolio manager Carl Kawaja. “I would not count out the incumbents.”


Old-guard companies in autos and retail are adapting to disruption


Sources: Capital Group, company financials, FactSet. General Motors sales includes SAIC-GM-Wuling joint venture. Target and Costco reflect fiscal year 2020 and 2019 sales. Home Depot reflects fourth quarter 2020 and fourth quarter 2019 sales.


Digital shifts continue to reshape U.S. economy


In a matter of months, COVID-19 jumpstarted years of change in the way we live and work — and the way companies operate. “Some companies saw their business models accelerate three or four years in 2020,” says equity portfolio manager Chris Buchbinder.


Digital payment technology, which accounted for 9% of total U.S. payments in 2019, accounted for 15% in 2020 — a 66% increase. Telemedicine, or online appointments, accounted for a fraction of total doctor visits prior to the pandemic, but about 20% of all visits in the early months of 2020. Will these behavioral shifts prove to be lasting?


“Growth may slow a bit in some areas, but I don’t believe we’ll see a reverse of these trends,” Buchbinder says. “For instance, many of the streaming companies are releasing new movies through their services at the same time they are in general release. When people physically return to cinemas, will this practice stop? I don’t think so.”


Leading digital trends still have massive growth potential


Sources: E-commerce = % of total U.S. retail sales (U.S. Census Bureau); telehealth visits = % of total primary care visits that were not in-person visits (U.S. Department of Health & Human Services, as of June 2020); streaming = % of time spent watching TV on streaming content (Nielson, as of 3Q, 2020); digital payments = % of payments made with digital wallets (Statista); cloud computing = % of total IT spend on public cloud computing (Capital Group, IDC).


Inflation: The elephant in the room


While the velocity of the U.S. recovery has been remarkable, it has triggered supply shortages, inflation and investor worries that it can be sustained.


If you’re trying to buy wood or a used car, you probably feel like inflation is out of control. But fears of rampant long-term inflation may be overblown amid longer term deflationary pressures, says fixed income portfolio manager Ritchie Tuazon.


“We saw in April that inflation basically exceeded the Fed’s target,” Tuazon explains. “But this is not due to a virtuous labor demand-driven inflation cycle. It is due to reopening of the economy and supply bottlenecks, which are more temporary. While we should continue to see inflation volatility, and I am watching inflation very closely, I expect it to return to pre-pandemic levels in time.”


If history is any guide, sharp increases in prices for raw industrial materials — copper, cotton, rubber, tallow and zinc, among others — generally do not have much impact on the Consumer Price Index (excluding food and energy), the most widely used gauge of long-term inflation.


Inflation has jumped but labor data suggests it may be temporary


Sources: Bloomberg, Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve. Inflation data as of 30/4/21. Employment data as of 31/5/21. Pre-pandemic peak considers the trailing 12 months prior to February 2020. Inflation shown based on the Personal Consumption Expenditure Price Index, with core excluding energy and food. Under-employment rate consists of total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons.


Investment implications


Concerns about inflation and rising rates seem overblown. Yes, we are experiencing a near-term spike in inflation but it’s likely temporary. And the Fed appears in no hurry to implement rate hikes as near-term price volatility moderates.


Some incumbent companies in industries like autos, retail and entertainment are adapting to disruptive forces reshaping the American economy.



Darrell R. Spence  is an economist at Capital Group. He has 28 years of investment industry experience, all with Capital Group. He holds a bachelor’s degree with honors in economics from Occidental College graduating cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics.

Hilda Applbaum is a portfolio manager with 32 years of investment experience. She holds a master’s in economics from NYU and a bachelor’s in economics from Barnard. She is also a CFA charternolder. 

Chris Buchbinder is an equity portfolio manager with 23 years of investment experience. He holds bachelor's degrees in economics and international relations from Brown university. 


 

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