Under The Hood

At the end of each year Americans learn the magnitude of their national economy’s growth over the previous twelve months. This number, the U.S. gross domestic product (GDP), functions like a speedometer.

Just as the number on a speedometer is the outcome of a complex machine, the GDP number is a simplified representation of the intricately complex web of transactions that constitute our economy. A positive GDP print represents expansion, while a negative GDP print represents contraction. This number can be sliced and diced in a variety of ways, but the primary factors that determine GDP growth are represented by the following formula: 

GDP = Consumption + Investment + Government Expenditures + Net Exports

In the paragraphs below we will break down how each of these elements are behaving and what it tells us about the health of the overall economy.


Consumption, or purchases made by households, typically make up around 70% of total U.S. GDP. Today consumption has fallen significantly and has not returned to the pre-pandemic peak.

Consumption numbers are not likely to rebound to pre-pandemic levels for some time. The permanent unemployment number, counting those who do not expect to find a job within the next six months or have not been provided a specific recall date, is currently rising at a faster rate than during the financial crisis.

The incomes of those who lost their jobs were buoyed by generous unemployment benefits through July 31. For a period of months aggregate incomes actually increased and many family incomes rose above the poverty line. To the surprise of the financial industry and political observers alike, these benefits have not been extended in any form. Since July 31st, incomes have dropped 50-75% for the largest unemployed population since the Great Depression.

Unemployed households, cash constrained due to their precarious situation, tend to spend the majority of their unemployment check, meaning the expiration of these CARES Act provisions will lead to a sharp drop in consumer spending, and in turn, corporate profits, a phenomenon that has already made an appearance in spending data for the month of August.


The investment component in the GDP formula refers to housing and business construction, inventory investment, and public investment like hospitals. It does not refer to stocks, bonds or similar financial assets.

Inventory investment has been fairly volatile over the past 6 months. When shutdowns arrived in March, many firms drastically reduced their inventory build in anticipation of a massive reduction in demand. At the same time, Congress passed a stimulus package that increased household incomes in aggregate, leading to higher levels of spending than forecast through July 31st. These higher than forecast spending levels caught those firms with low inventories by surprise, leading to a swing in the opposite direction. As stated above, without an extension of CARES Act provisions, the 50-75% reduction in the incomes of the unemployed will likely lead to a reduction in inventory investment within the next six months as a decline in spending leads to a reduction in new orders by retail establishments.

Commercial real estate construction, being a long-term capital outlay, has been consistently depressed. The American Institute of Architects (AIA) has issued a forecast predicting the following:

The AIA Consensus Construction Forecast Panel—consisting of leading economic forecasters—projects spending on nonresidential facilities will decline just over eight percent this year, and another five percent in 2021. The commercial building sector is expected to be the hardest hit, with spending projected to decline almost 12 percent this year and another eight percent in 2021. The industrial sector is slated to see declines of five percent this year and three percent next year. While institutional buildings will fare the best on the nonresidential side, spending on these facilities is projected to drop almost five percent this year, and another two percent next.

The construction slowdown is being led by business spending decisions. On September 17th the CEO of the world’s largest asset manager, BlackRock, stated that perhaps only 60% of their employees will return to the office, the rest permanently working from home. As more companies makes similar decisions the market for existing commercial real estate has been significantly weakened, leading one industry pioneer to state that “…it is nearly impossible to establish values for a lot of commercial real estate today.” An increase in commercial real estate construction will likely be preceded by stabilization in the values of commercial real estate already in existence.

Residential real estate investment will likely be driven by the same consumption factors influencing inventory investment, though perhaps with a delay. CoreLogic forecasts that economic forces will push home prices down -6.6% by May of 2021 as foreclosures and delinquencies continue their rise. In such an environment for existing housing stock, we can extrapolate that home construction will be depressed.

The other portion of residential real estate investment, multifamily housing construction, is currently declining by double digits. Prior to the eviction moratorium by the CDC it was estimated that 30 to 40 million renters were at risk of eviction through 2020. Given that the eviction moratorium provides no cash flow relief for the owners of rental property, many of whose properties are mortgaged, this worsens the prospects for future multifamily construction.

Regardless of election results, I am hopeful that the third component of investment, public infrastructure,  is increased through governmental action in the next administration.

Government Expenditures

Federal government expenditures make up around 89% of the total for this category, and 60% of those expenditures go towards funding the U.S. military. 11% of overall government expenditures are found at the state and local levels. If we do see a decrease in government expenditures this year it will likely come from the state and local segment, which has struggled with severely reduced tax revenue. In light of this problem, proposals to send federal aid to state and local governments are currently under discussion on Capitol Hill.

Typically government expenditures increase during economic crises in order to boost overall economic growth and provide a source of demand not subject to market conditions.

Net Exports

The final component of GDP is net exports. The trade gap in July was the largest since the financial crisis. With the global economy projected to decline by -4.9% (IMF) in 2020 it is unlikely that this number will rise substantially anytime soon. 

Given the prospects for each of the components discussed above it is easy to see why U.S. GDP is projected to contract at -5.6% in 2020, the most severe contraction since the end of World War II. On the bright side, we have only seen two recessions in the postwar era in which GDP has contracted two years in a row: 1974-75 and the years comprising the financial crisis. That being said, this recession is unique in that its origins are biological rather than economic in nature. While normally we would expect the healing of the credit market to signal a return to on-trend economic growth, we will likely have to wait for a vaccine to see our economy run at full horsepower.

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