Readers are probably tired of hearing about the pandemic’s effect on economic output. I get it. But with the pandemic worsening in the U.S., and with full vaccine rollout probably six months away, we’re entering a critical phase in the economic recovery. The first quarter of the new year will be a major litmus test, and many are wondering if we’re heading for a double-dip recession.

The answer to the recession question is complex. Fresh economic restrictions may play a key role in the country’s ability to sustain the economic recovery through the end of the year and in Q1. New York announced last week new criteria for rolling back the state’s reopening plans, and both California and New York are introducing shutdown restrictions based on hospital capacity. More states may follow.1

I have no experience in public health matters. But what I do know is that there is an inverse relationship between economic restrictions and economic output (GDP). More restrictions mean less output, and vice versa. From an economic forecast perspective, then, it’s critical to watch how the winter unfolds with the pandemic and state-by-state restrictions. It will be key in determining if we do in fact experience a double-dip recession.

There are a few other factors in play. For one, the first quarter has generally been a soft spot early in economic recoveries. In 8 of the last 11 business cycle recoveries, there has been a Q1 setback before the expansion continued. So, there’s cyclical weakness to consider here.

Second, economic uncertainty in the U.S. remains at or near record levels. Economic uncertainty can weigh on economic growth, in a few ways – businesses tend to delay or pause investing in major projects, consumers ‘hunker down’ and favor saving over spending in the holiday season, and fiscal stimulus becomes less effective when businesses opt to hoard cash rather than deploy it. In short, confidence and positive sentiment matter quite a bit, and we’re approaching a final leg in the pandemic that stands to challenge both.

Finally, there’s the U.S. dollar. The dollar continues to weaken relative to developed world currencies, most likely a result of high deficit spending and additional debt accumulated to battle the pandemic. The Wall Street Journal dollar index, which measures the dollar against a basket of other key world currencies, fell last week to its lowest level since April 2018. With more fiscal stimulus likely on the way, the dollar may have further to fall, which for the economy could ultimately mean higher inflation and higher interest rates in the medium-term.

In my view, there are many forces trying to push back on this economic recovery, and again, these next three to six months will be critical. But there are also positive forces at work. Early fourth quarter economic data has been holding up quite well – the Institute for Supply Management’s (ISM) November survey showed construction spending rise to its second-highest level on record, and other readings regarding durable goods orders, home sales, and consumer spending showed resilience in October. The Atlanta Federal Reserve’s model for predicting GDP, called GDPNow, is predicting an 11.1% annualized growth rate for Q4, which is a strong improvement from the 2.2% rate predicted just a month ago.

At the same time, areas of the economy like factory employment, hospitality, and personal incomes continue to struggle, and there are signs consumer spending is softening: data shows that U.S. consumers spent an average of just below $312 on holiday-related purchases from Thanksgiving to Cyber Monday, which is down 14% from spending in 2019. The number of in-store shoppers plummeted 37% from a year earlier on Black Friday, though online shoppers rose 8% on the same day.2 It’s a mixed bag.

Bottom Line for Investors

Here’s my message to investors: even though we’re wading into a critical, uncertain period to finish this year and to start the new one, remember that investing should look beyond the short-term to focus on what the economy may look like in the next six to twelve months.

And, if we’re talking six to twelve months, that means looking past any potential backsliding in Q1 2021, and instead focusing on the possibility of strong growth by next summer or next fall. If you think a vaccine rollout will reduce the pandemic uncertainty and allow the economy to function normally again – which I do – then now is the time to position for that possibility. Don’t worry too much about what happens economically in the next three months, in my view.

Disclosure

1CNBC. November 30, 2020. https://www.cnbc.com/2020/11/30/virus-is-leading-to-double-dip-recession-dollar-crash-stephen-roach.html

2 Wall Street Journal. December 1, 2020. https://www.wsj.com/articles/number-of-black-friday-in-store-shoppers-fell-37-11606841884

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