According to the Bureau of Economic Analysis, the U.S. economy grew at an annualized rate of 6.5% in the second quarter. Many areas of the economy are still in recovery mode, but for all intents and purposes, the U.S. economy is back to its pre-pandemic size – and we see plenty of runway for growth ahead.
The surge of activity in the first half of 2021 was largely expected and has been great for many households and businesses. Consumer spending persists as the lead driver of the expansion, with spending up 11.8% in the three months ending June 30—the second-best performance since 1952. Business investment also rose 8%, adding 1.1% to the total GDP number.
The drag on U.S. economic growth in the second quarter came from inventory drawdowns, which subtracted 1.1% from GDP, rising imports, and a decrease in federal government spending. According to the Bureau of Economic Analysis, nondefense spending on intermediate goods and services fell the most, largely due to a drop-off in Paycheck Protection Program (PPP) loans.1
The return to growth has been welcomed and also positive for the equity markets, in my view. But based on our forecasts here at Zacks Investment Management, the 6.5% Q2 growth rate is likely to be the fastest the U.S. economy will deliver in this cycle. Meaning, we may have just seen ‘peak growth’ in the economy, with spending and GDP expansion set to slow from here. The effect of stimulus payments is fading, there is a low likelihood of another round of direct transfers (fiscal stimulus), and the U.S. economy looks poised to settle into a more modest, sustainable rate of growth:
Federal Reserve GDP Growth Estimates 2021 – 2023 (Median)
Source: Federal Reserve Bank of St. Louis2
The moderating pace of GDP growth has some investors worried. If the economy has peaked, does it mean stock returns may have peaked, too?
I think the answer is no – and history suggests it is, too. Take the period from 1995 to 1999, for example. Most readers remember this as a period of high-flying growth, thanks to the blooming age of the internet. Over those four years, the U.S. economy was averaging over 4% GDP growth – quite strong. The weakest growth year in that period was 1995 when the U.S. economy ‘only’ expanded 2.7%. But the weakest GDP growth year also delivered the strongest year for stock returns, with the S&P 500 rising over +35%. The stock market may have been discounting the strong growth years that would follow, granted, but who is to say 2022 and 2023 will not be better-than-expected growth years?
One more example to offer some additional context. From 2009 to 2019, the U.S. economy averaged just 1.9% of GDP growth, which was about half the growth rate it averaged over the previous 20 years. Historically speaking, this was considered weak growth. But there was not a noticeably adverse impact for S&P 500 returns—from 2009 to 2019, the index rose +351%!3 The third-weakest year in the stretch, 2013, was also the best year for stocks in that bull market.
Bottom Line for Investors
The U.S. economy likely peaked in Q2 2021, and growth is poised to slow from here, in my view. But that does not necessarily spell doom for the U.S. economy or the stock market. Just because growth is slowing does not mean it’s stopping or reversing. As I look out at corporate earnings estimates, household and corporate balance sheets, business investment, and monetary policy (among other economic fundamentals), I see positive dynamics and a positive outlook.
I have written before in this column that ‘growth is growth,’ even if it is slowing down from a peak or moderating over time. But I think it is also important to note that consensus has U.S. economic growth slowing from here, meaning that growth expectations are also falling. In my view, that’s good news for stocks – if growth expectations fall quickly, it means positive surprises are more possible, which I think is a key driver of returns.