Yesterday, the Bureau of Labor Statistics (BEA) reported the US economy grew at a 2.0% annualized rate during the 3rd Quarter of 2021. This was slower than analysts were expecting, and much slower than 2nd Quarter’s feverish 6.7% clip. What in the world happened?
According to the report, it seems US consumers decided to quit buying durable goods (items expected to last more than 1 year) last quarter. More specifically, they stopped buying automobiles, and in a big way. The BEA estimates personal consumer expenditures (PCE) for durable goods fell a whopping 26.2% during the 3rd Quarter, and what we spent, or didn’t as the case may be, on vehicles shaved a full 239 basis points (2.39%) off the entire equation.
In English, but for the swoon in automobiles, the US economy would have grown 4.39%, as opposed to the announced 2.0%. So, what does this mean for the economy as a whole? Are we slipping into recession? Are we about to pay the piper for all of this money we have been throwing about?
Simply put, a slowdown in consumer spending was a given. There was no way the US consumer could continue their torrid pace for much longer. It is sort “just math.” Consider this: PCE for durable goods grew at an 89.0% rate during 3Q 2020, at 1.1% during 4Q 2021, at a 50.0% clip during the first three months of the year, and a still strong 11.6% during the 2nd Quarter.
However, we can’t put all of the blame on “just math.” Oh no. A huge chunk of the problem is a global ‘chip’ shortage, and, of course, I don’t mean snack foods. The US has more than enough bags of delicious, but empty, calories to go around several times. Nope, I mean computer chips, semiconductors, microprocessors and the like. It has been a perfect storm.
Let me explain the problem using bullet points:
- Automakers use relatively low-tech, low-margin chips called microcontrollers in their vehicles. After all, you aren’t trying to mine cryptocurrencies with the computer(s) in your car.
- Automakers canceled chip orders at the start of the pandemic to avoid having too much inventory, and not enough demand.
- Chipmakers shifted their capacity to consumer-electronics producers, who use higher-tech, higher-margin chips.
- Auto demand surged, but the supply of low-tech chips didn’t, and, as we all know, supply-chain bottlenecks have hampered distribution for just about everything in the economy.
- Finally, chipmakers are hesitant to add capacity to manufacture the lower-margin chips, because they are not sure if the surge in vehicle demand is sustainable.
As Mike Colias of the Wall Street Journal explained in an excellent article on the subject on September 30th:
That part of the supply chain is expected to experience an extended backlog for chips used by the auto industry as well as other sectors, even if pandemic restrictions ease, said Phil Amsrud, a senior analyst at research firm IHS Markit who specializes in the automotive-semiconductor market.
“These back-end companies run at much thinner margins” than the semiconductor manufacturers, Mr. Amsrud said. “For them to make a big investment in capacity, they need to be absolutely sure of the short-term and long-term demand…”
One factor that leaves the auto sector at a potential disadvantage is its reliance on older chips, called microcontrollers. They have been used for decades to electronically control engines, air bags and other vehicle functions, and are pervasive because of their low cost and reliability.
But of the nearly $400 billion that semiconductor companies have announced in planned capacity expansions, little of it is expected to go toward microcontrollers, according to IHS.
Semiconductor companies lack incentive to invest in additional capacity for older technology, RBC Capital analyst Joseph Spak said. And while auto makers are moving toward more-advanced chips as they introduce electric and connected cars, that upgrade will put them into more-direct competition for chips with makers of consumer electronics, he said.
Perhaps this understanding of the situation was the reason why the markets didn’t respond negatively to the relatively ugly headline number. They knew the sector was going to be bad, just not how bad, and Tables 1 & 2 of the release told them it was worse than expected. Strangely enough, it sort of brought a collective sigh of relief.
First, overall PCE was relatively strong. Ex ‘motor vehicles & parts,’ it grew at a 5.4% annualized rate during the 2nd Quarter, which is decent strength by anyone’s definition. Second, despite the slowdown in production, US automakers Ford and General Motors reported strong quarterly earnings per share. Third, slower headline GDP growth could very easily keep the Federal Reserve on the proverbial sideline that much longer.
You see, regardless of the reason, an economy growing at a reported 2% annualized rate is not in danger of ‘overheating.’ As such, there would be little reason to start draining reserves from the financial system, and/or reducing the available supply of credit. Therefore, the Fed doesn’t HAVE to be in a big hurry to do anything other than fill the proverbial punch bowl, while keeping the hammer down.
The investment markets can be strange like this, turning bad news into good news. Perhaps we can say investors turned yesterday’s GDP lemon into lemonade, and that is a good thing. Then, the President made his case for the ‘social-spending, climate package.’
Let’s just say, the proposed tax increases weren’t as dramatic as many had feared, and that might be an understatement. The following blub(s) from Ken Thomas, Siobhan Hughes, and Natalie Andrews at the Wall Street Journal summed it up best:
Those levies would hit high-income people but wouldn’t address key targets of Democrats’ tax-raising aims—billionaires who are seeing their wealth increase without reporting much taxable income.
The plan will also include a 15% minimum tax on profitable corporations, higher taxes on U.S. companies’ foreign income and money to increase the Internal Revenue Service enforcement staff. It will also include a 1% excise tax on corporate stock buybacks.
The tax plans do focus on high-income households and corporations, but other revenue-raising ideas proposed by the administration and by congressional Democrats appear to lack enough support for now. Those include a tax on billionaires’ unrealized capital gains, a rule requiring banks to report account flows to the IRS, changes to estate and gift taxes and higher corporate tax rates.
Put another way, Washington intends to dump another $1.85 trillion on the economy with little change to the current tax structure, at least at first blush.
When you combine the two, you get: continued accommodative monetary policy and a sharp increase in fiscal policy. Those two things have usually engendered economic activity, at least in the short-term. If that is the case, I will take a 2% GDP headline number most days of the week, I mean if it keeps the good times rolling.
We can discuss the longer-term impact of all of this financial foolishness at another time.
Take care, thank you for your continued support, and be sure to listen to our Trading Perspectives podcast.
Chief Economist
As always, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, are subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the reset of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.