It’s been 10 months since the first COVID vaccine was given in the U.S. Since then, we’ve all kept a steady watch on the economy, waiting for signs of recovery as states suspended stay-at-home orders and people started returning to work. Just when it looked like the worst of the pandemic was behind us, the Delta variant appeared in the summer, sending case counts — and prices — rising.
Fears of another round of government shutdowns coupled with the threat of inflation have helped slow consumer spending in recent months. By the end of the summer, there was a noticeable decrease in the amount of money being spent on air travel and dining out — flashbacks of what happened in the spring of 2020. Is this a temporary dip or a harbinger of more volatility in the market? How should investors respond to these changes?
What Exactly Is Going On With Consumer Spending?
The first question to tackle is whether the downturn in consumer spending is, in fact, a sign of a slowing economy. In the spring, the country seemed to overflow with optimism, as the vaccine rollout and declining case numbers made it possible for people to venture back out into public. Larger numbers of employees started returning to their offices. Cruise ships set sail. Theme parks welcomed guests. Restaurants opened dining rooms. There was even talk of Broadway reopening — a sure sign that the economy was on the rebound.
According to the Bureau of Economic Analysis’ July report, consumer spending continued to increase in July (U.S. Department of Commerce, 2021). It was just a modest increase of 0.3% that paled in comparison to the previous month’s 1.1% increase. This dip reflected issues like the continuing semiconductor shortage that has hampered production in the automotive industry. Spending on recreational goods, clothing, and shoes also fell during this period. (This should not be much of a surprise, though, as there are only so many dumbbells one person can buy for home workouts.)
The “I” Word
Talk of inflation was inevitable as the Consumer Price Index started showing increases in the cost of goods. More than one-quarter of Americans surveyed (PBS Newshour, 2021) in July said they were more concerned about inflation than they were about wages and unemployment. Then August prices went up 5.3% year over year and 0.3% over the previous month. Notably, the cost of food, gasoline, housing, and furniture increased, raising concerns about how well people could pay their bills.
Yet, this price increase was not a surprise to the Federal Reserve. In fact, the Fed had already warned the public that inflation would rise as the economy adjusts its way back to normal operating conditions. Prices are reflecting shifts in supply and demand that should even out over time. For example, the record-setting increases in the price of steel and lumber can be traced, in part, back to supply shortages caused by factory shutdowns. At the same time, demand increased as stuck-at-home Americans tackled home improvement projects. When construction started picking up again, the sawmills couldn’t keep up with demand, and prices skyrocketed.
Inflation isn’t necessarily bad, and the Fed appears to support that idea. Often, we only think about the negative side of inflation as we see increased prices. But asset inflation has benefited millions as 401(k) balances and brokerage accounts have skyrocketed as markets continue an almost uninterrupted climb. Of course, this is not an invitation to be blind to price increases, but inflation does not necessarily need to be a curse word. And with cost side inflation, as prices increase, demand can slow long enough for supply to catch up and lower prices again.
Business Is Still Booming in Much of the Country
The cost of consumer goods only tells part of the economy’s story. It’s also helpful to examine the state of the nation’s businesses. During the pandemic, an influx of cash from the federal government made it possible for companies to strengthen their balance sheets, keep their employees employed, and avoid permanent closure. Many of these companies used the downtime of the pandemic to reevaluate their priorities and shift their focus. (we argued previously in this space that while we disagree with the broad approach taken by the Fed, COVID-19 and the eventual shutdown of the economy required action)
A survey conducted by the U.S. Bureau of Labor Statistics revealed some surprising details about the effect of the pandemic on small businesses across the country. More than three-fourths of finance and insurance companies paid their employees even if they weren’t working. The same was true in more than half of health care and social assistance organizations and nearly one-third of restaurants. Nearly one-third of businesses that received a loan or grant during the pandemic were able to continue paying their employees during the shutdowns. Some employees also continued receiving health insurance in addition to a paycheck.
That’s not to say that businesses have survived the pandemic unscathed. A closer look at who did and didn’t work during the pandemic shows a significant disparity in how it affected businesses. Large companies were more likely to pay their employees compared to smaller companies in the same industry. Utility establishments generally continued working throughout the pandemic.
Companies in the finance and insurance sectors typically kept working, in many cases shifting their operations to remote work. All of this taken together helped an economy suffering from the shock of a sudden stop recover, even if it was artificially propped up via US taxpayers.
This Isn’t Your Father’s or Grandfather’s Recession
If any of this sounds familiar, it’s probably because we’ve seen these patterns before. Unemployment rose during the Great Recession, especially among less educated workers. Even then, researchers compared what was happening to previous downturns, noting that they were different in size and scope from what the world was experiencing at the time.
It’s natural to examine what happened in the wake of previous economic slowdowns to help us predict what may happen next. However, we’re not living through another Great Recession or Great Depression. The underlying factors contributing to the pandemic recession are very different from what we saw in the Great Recession. Economists recognized these differences early in the pandemic and as early as March 2020 were predicting the downturn would be “shorter and shallower” (Scheiner, 2020).
For now, there are few compelling reasons to believe differently. Consider the following differences between the pandemic-related downturn and the Great Recession.
• There is no consumer debt overhang. Instead, people have been able to save money and pay down debt during the last year since they weren’t spending money on entertainment, vacations, and commuting. Before the Great Recession, too many Americans held mortgages they couldn’t pay.
• There is no bursting asset price bubble. A collapsing housing market ushered in the Great Recession. The current dip was shocking, and it was directly connected to the stay-at-home orders and concerns about the spread of the COVID-19 virus.
• There are no long-term business cycle fluctuations. Spending slowed because the public was asked to stay home. It was sudden and clearly not part of a traditional business cycle that can ebb and flow.
Compared to previous recessions and depressions, Americans have been able to save an impressive amount of money — more than $1.6 trillion (McKinsey Global Institute, 2021). Individuals in the middle class saw some of the greatest increases in savings. They also were more likely to use it to pay down debt. These savings tend to be concentrated among older people who may not be as quick to resume pre-pandemic behaviors until Delta fades
What Is Going On With the Economy?
People are working. Businesses are closing transactions. There are canned goods and toilet paper on the shelves at the grocery store. These are signs that the economy is booming, right?
Economists are confident that the economy will recover, but the recovery will probably be as uneven on the way up as it was on the way down. It’s reasonable to expect the recovery to vary based on geographical location, age, and income (Consumer Demand, 2021). The Delta variant has been especially strong in certain regions of the country, slowing the recovery as case numbers increase — keeping workers out of the field and hospital staff busy.
Lower income workers and young people were disproportionately affected by business shutdowns and more likely to spend the money they were saving to cover living expenses. Some of them are still waiting for their jobs to come back, while others decided to change careers. It may be years before we know how this decision will impact that group because income gains from career change may or may not materialize. Many middle-income earners used their extra funds to pay down debt, while higher income earners received the least amount of public support.
One of the more pressing questions at the moment is when Americans will start spending their pent-up savings. There is still a considerable amount of money out of circulation. As spending increases, so will demand. This can lead to another spike in prices for the most in-demand products and services. Increased prices strain low-wage earners the most, decreasing their buying power. With that strain may come increased political pressure which will likely lead to more bad policy at the Fed.
What Does All of This Mean for Today’s Investor?
The shifts in consumer behavior during the pandemic may provide some clues to the future of business in the U.S., as some of them will be permanent changes. E-grocery shopping and virtual health care visits (McKinsey Global Institute, 2021) will likely stay even after business returns to normal. Home nesting habits, including home gyms, backyard entertainment areas, and home improvement, should continue for now. Distance learning, air travel, and live entertainment will most likely go back to pre-pandemic levels, even if it takes several years. All this means is that consumers will find ways to spend money. And that spending is good news for investors.
Consumer spending isn’t the only factor in play. Supply chains and infrastructure also play a role in the decision-making process. A disruption in the supply chain can slow production, which increases demand and prices until the supply side catches up. Workers with reliable internet access at home may be more willing to continue working from home, while others need to go to the office to get work done.
Commodities have been popular during the last year as the price of steel and lumber hit record highs. Some of the spike is a result of supply disruption, and as the global economy recovers (which so far has happened at a slower pace than the U.S. economy), demand for commodities may also increase. Technology will continue to be a hot sector. Businesses are trying to adjust their legacy business models to accommodate digital transformation. They need software, platforms, and personnel to make it happen.
And it most likely will happen. Disruptions in business lead to opportunities for those willing to take a chance. The economy moves in cycles, and it will survive this dip. We will continue to find opportunities with an acceptable amount of risk.
- Belsie, Lauren. (2011). Job loss in the Great Recession. National Bureau of Economic Research https://www.nber.org/digest/sep11/job-loss-great-recession
- Briggs, Joseph and Mericle, David. (2021, February 15). Pent-up savings and post-pandemic spending. U.S. Economics Analyst. Goldman Sachs.
- Bureau of Economic Analysis. (2020, August 27) Personal income and outlays, July 2021. U.S. Department of Commerce. https://www.bea.gov/sites/default/files/2021-08/pi0721_fax.pdf
- McKinsey Global Institute. (2021, March 17). The consumer demand recovery and lasting effects of COVID-19. McKinsey and Company.
- Remes, Janna and Fabius, Victor. (2021, May 12). 3 reasons why consumer demand matters for the post-COVID-19 recovery. World Economic Forum.
- Scheiner, L. (2020, March 12). How does the coronavirus pandemic compare to the Great Recession, and what should fiscal policy do now? Brookings Institute.
- Stang, Sharon (2021, July). Impact of the coronavirus pandemic on businesses and employees by industry. U.S. Bureau of Labor Statistics.
- Vinopal, Courtney (2021, July 2). A quarter of Americans are worried about inflation. Here are 4 things to watch for. PBS News Hour.
- Wells Fargo Investment Institute (2021). The new landscape: investing in post-pandemic markets. Wells Fargo & Company.