Today I want to talk to you about a recent report which found that the American GDP fell by 32.9 percent on an annualized basis in the second quarter, meaning April through June of 2020.
How Is GDP Growth Annualized?
Now to clarify that doesn’t mean that we produced 32.9 percent less value in the second quarter compared to the first. What it means is that if the economy continued to contract at that rate for four quarters, you would get an annual decrease of 32.9 percent. I don’t want to turn this into an article on math, but I do want to explain how annualized growth is calculated, or annualized loss in this case.
Basically you take the difference between the two quarters, express it as a ratio, then take that ratio to the fourth power—since there are four quarters—and subtract one. In the same way you could annualize a monthly rate, for example, by taking the ratio to the twelfth power instead of the fourth.
Annual growth = ((1 + quarterly growth rate)^4) – 1
How Does 2020 Compare to Other Recessions?
We all know the effect coronavirus has had on the world market, but also the American economy in particular, so it’s not necessarily surprising to see a significant change from the first quarter to the second quarter.
This trend didn’t start in the second quarter, in fact the GDP decreased by just under 5 percent in the first quarter. That was bad news at the time, it was actually the first decrease since 2014 and the worst quarter since the 2008 recession, but 32.9 percent annualized is really in a different category compared to what happened in the first quarter.
How Is GDP Calculated?
I should probably clarify how GDP (gross domestic product) is counted. It essentially represents the value of everything that’s produced in a country over a certain period of time.
You could also measure state or city GDP, it doesn’t necessarily have to be at the national level, but that’s the figure in this case.
Is Government Spending Included?
So it’s worth noting that some forms of government spending are included in GDP. Things like building roads and funding firefighters, for example, the government calls these consumption expenditures and gross investment, and they’re included in GDP which means they’re part of that 32.9 percent figure.
On the other hand, things like Social Security benefits, unemployment benefits, or stimulus checks, these are called transfer payments, and they aren’t included in the GDP because they aren’t associated with any product or service.
And that’s where the stimulus bill comes in—we knew there was going to be a slowdown, and those payments can counter the impact of shutting down the economy by making sure people get the money they need. But that’s also why they aren’t included in GDP because the person who receives them isn’t putting something back into the economy in exchange.
With that being said, if you go out and spend your stimulus money, you buy groceries for example, that will be counted in the GDP because you were paying them for something, you weren’t just giving them money.
2020 vs the Depression
If you look at that 32.9 percent figure, obviously that’s an incredible drop from one quarter to the next, and it’s the largest single-quarter drop since we started measuring quarterly GDP in 1947. In fact it was more than three times as severe than the previous worst quarter, which was April to June of 1958.
Now this wasn’t being measured in the same way during the Great Depression, but the estimated total drop was around 30 percent. If you add the first and second quarters of 2020 we’re currently at almost 38 percent. So it isn’t an exaggeration to say that this is at least as severe as the Depression in terms of quarterly contractions.
How Bad Will the Recession Get?
That said, I want to mention here that this doesn’t mean that the overall impact will be as widespread as the damage of the Depression. That contraction started in October of 1929 and didn’t reach its lowest point until 1933, so that’s four years of sustained economic hardship, high unemployment, a steep market crash, and of course lower GDP.
What Will Recovery Look Like?
No doubt it will take both the US and the rest of the world years to get back to normal following coronavirus, or the new normal. But if we are able to get it under control, and especially if we can develop a successful vaccine, maybe we’ll have the opportunity to start reopening more quickly.
Best Case: V-shaped Curve
And in that case the curve would look more like a V, a sudden drop followed by rapid recovery, this is called a V-shaped recovery like during the Recession of 1953. Trump has talked a lot about turning this recession into a V-curve. And even though the second quarter of 2020 would still be the worst quarter in modern American history, we could potentially avoid the kind of ongoing economic decline that we saw during the Depression.
Worst Case: Ongoing Damage
Of course things could also go in the opposite direction, the vaccine could take longer than expected, outbreaks could get worse as some schools go back to in-person instruction, and in that case it’s going to be harder for companies to get their employees back to work. So what makes this situation unique is that everything flows out from our ability to fight the virus itself.
Some countries have successfully lowered their case counts, which means they’ve been able to start opening more businesses and more schools and use quarantining, contact tracing, and other resources to limit outbreaks when they do happen. Unfortunately this is not yet possible in the United States, and when cases are widespread it becomes harder and harder to open those public spaces without losing control of the outbreak.
This isn’t to say that public health is the only factor to consider here, but I think it’s safe to say that the worst effects of the recession will continue to depend on our ability to limit cases and eventually develop a vaccine. If we’re shut down for three or six months, the government can cover more of those losses, and most businesses will hopefully be able to open back up when the lockdowns end.
The problem is if that transition takes longer, if we’re locked down for a year or two, for example, those companies, particularly small- and medium-sized businesses, they’re not going to have the resources to reopen, and that will lead to a new set of problems.
And in some cases we’ve seen what’s called a W-curve like in the early 80s, which is when a country begins to recover from a recession but then hits some obstacle and loses that progress.
For example, if the economy starts to open before we have cases under control, that could increase GDP for a short period of time, and it might look like we’re recovering. But again if there’s a second wave, if we have to start a second lockdown, obviously the economy will stagnate again and it could take even longer to recover.
There are a lot of factors at play here, so it’s hard to predict what the pandemic will look like in six months, but these are some of the most plausible outcomes based on everything we know right now.
The Impact of COVID-19 on Different Industries
One thing I want to point out about this recession is that it’s targeting certain industries, so even though most fields are in trouble some are actually doing great right now. Now that’s true of the economy in general, nothing affects every industry in the same way.
But you can really see the difference in this case—for example, video games and delivery services do better with more people at home. Compare that to movie theaters and restaurants, that’s where the money is coming from, instead of going to see Mulan maybe now you’re having a Nintendo Switch shipped to your house.
So part of the next few months will be reorienting our economy, at least until we get the pandemic under control, around a new set of customer preferences. And over time we’ll see where that settles, some changes may be permanent, some industries might be back to normal in a year or two.
What About the Election?
Another major topic that you can’t avoid mentioning when you talk about the recession is the election. Now I don’t want to make this a political piece, and I definitely don’t want to make it about Biden or Trump, but the market is always based on how people feel about the future.
No matter what your views are, each of the major candidates could have both positive and negative effects on stocks, jobs, and GDP. A lot of people expected the market to crash when Trump won in 2016, but it actually went up the next day after dropping on Election Day as more and more results were coming out. And from there the S&P 500 went up almost 50 percent from the beginning of 2017 to the end of 2019.
On the other hand, wages haven’t grown as much during Trump’s administration, and obviously a lot of those market gains were wiped out by the pandemic only to now be recovered. So these are complicated issues, but stocks did pretty well under Trump until this year. They dropped, and now they’re up again, and GDP rose by an average of 2.5 percent from 2017 to 2019.
Furthermore, the economy has always been one of Trump’s strongest issues in terms of public opinion. For example, a new YouGov poll found that 49 percent of voters either strongly approve or somewhat approve of his approach to jobs and the economy, even though just 40 percent supported him for President.
That said, only 33 percent of respondents were confident in his ability to respond to the pandemic, compared to 55 percent who were uneasy about it and 12 percent who were unsure.
When voters were asked the same question about Biden, 32 percent said they were confident, 45 percent uneasy, and 23 percent unsure. So that’s not great either, but it’s still better since the people who said they were unsure would presumably split to both sides if Biden was elected and we had a chance to see him in office.
We’ll have to wait and see what happens over the next few months, but with how unpredictable things are right now I wouldn’t be surprised to see some kind of significant market reaction after the election regardless of who wins.
All right everyone I hope this article answered some of your questions about the recent GDP news and the recession in general. I know it’s a complicated situation, I wish I could tell you exactly how the next few months or the next year are going to go, but I don’t want to misrepresent the situation.
Ultimately this second-quarter drop could end up being a short-term response to the lockdown and the economy could start to bounce back in 2021, or it could end up being the start of a longer recession. Either way I’m going to be right here to tell you all about it, so as always stay tuned for more updates on the recession, stimulus, and everything else that’s going on in 2020.