February 25, 2021 | Bill Handel
A year containing a pandemic is, generally speaking, not a great year to have made predictions. In this review of the predictions we made for 2020 in January of last year, we will eat some crow. However, many of the things we thought might happen did, in fact, turn out to be the case. 2020 was a wild and woolly year, but on balance we were surprisingly prescient. However, we did miss clearly on the start and the magnitude of the recession.
Here are the predictions made last year and an assessment of each’s accuracy.
GDP Will Slow but Remain Positive
We expect growth to slow in 2020. No, this is not due to the coronavirus, which is in the news now, but instead is just the aging of the current expansion, which is now going on 11 years in duration – the longest expansion in U.S. history. Expansions age, just as we all do, and as they age, they slow down.
However, we do not anticipate a recession will occur in 2020; that will likely wait until 2021. As noted above, while the coronavirus will have an impact on GDP, and the inverted yield curve we are now experiencing is indicative of a slowing economy, the real issue is the slowdown in private domestic investment, which has declined by 3.4 percent since the first quarter of 2019.
Just to note, there have been 11 recessions since the end of World War II, and those have lasted on average just under one year in length. The most recent recession in 2008–2009 was the longest since the Great Depression and the deepest – 18 months and a cumulative 5.2 percent decline in GDP. Most recessions are nowhere near this severe, and the next one is not likely to be either.
A clear miss. In fact, we were a year off, as we predicted a recession in 2021. We also predicted a moderate recession, also a clear miss. Instead, 2020 showed a cumulative decline in GDP of 3.5 percent – the strongest decline since 1946. We’ll blame our faulty prediction on COVID-19!
Housing Starts Will Grow
While we anticipate a slight slowdown in the economy generally, we believe housing markets will remain reasonably strong due to two factors: lower interest rates and the number of young households being formed. Housing starts in the U.S. have grown every year since 2010, and while the growth rate in the past three years has not been as strong as in the earlier years of this expansion, demographic patterns will support continued strength in housing. After all, the latter half of the millennial generation is larger than the first half, and the Gen Z population is equally large and its impact on housing – especially multifamily units (for example, apartment dwellings) is beginning to be felt.
Accurate. Housing starts grew by 8 percent in 2020 for precisely the reasons we noted. This was the strongest increase in housing starts since 2015, and we expect this to continue in 2021. In fact, the housing market should remain hot for all of 2021 and into 2022.
Unemployment Rates Will Rise
Unemployment rates are at historic lows and the labor force is tight; however, we already are experiencing some of the changes in employment patterns associated with an aging expansion – corporate downsizing and layoffs, for example. While we don’t think the rise in unemployment will be severe, there will be an upward trend. The decline in domestic investment noted above is also a further reason we anticipate a slight rise in unemployment rates. Less business investment translates into lower levels of hiring.
Accurate. Unemployment ended 2019 at 3.6 percent. It ended 2020 at 6.7 percent What we did not anticipate was the roller-coaster ride in employment that we saw in 2020, with 25 million jobs lost between February and April, and almost 17 million new jobs added the rest of the year. We anticipate that unemployment will remain elevated in the first half of 2021, but significant job gains are likely in the second half of the year.
The Fed Will Lower Rates Three Times in 2020
Beyond the 50-basis-point rate reduction announced this week, we anticipate the Federal Reserve will lower rates two more times, most likely in the second half of 2020. Rate reductions may help to spur some level of increased business spending and will also support the real estate markets.
Accurate – in essence. While the Fed reduced its target rate only twice in 2020, the second reduction in March was to a level as low as they could effectively go unless the Fed were to resort to negative interest rates as we have seen in other parts of the world. We anticipate rates remaining low through the duration of 2021 even as economic activity picks up more significantly in the second half, as the Fed will want to ensure the stability of the recovery.
The Household Debt-to-Income Ratio Will Improve
Despite a softening economy, wages will continue to grow, and despite much of the press chattering to the contrary, consumers actually have been reasonably responsible with their debt in this expansion. Household debt measured as a percentage of disposable income, currently at 92 percent, is lower today than it has been since the first quarter of 2001. And it’s certainly lower than its peak level of 130 percent in 2007. We expect this ratio to decline further in 2020, as consumers become a little more cautious with their finances.
One caveat to this is student loan debt. While consumer debt other than student loans is not growing as rapidly as income levels, student loan debt continues to grow much more rapidly than income. The result is that those carrying student loans – generally younger individuals – may be feeling the impact of heavier debt burdens than is the general population.
Accurate. The debt-to-disposable-income ratio did drop (improve) in 2020; by the end of the third quarter, this ratio was at 88 percent. Even with the strong real estate market, overall consumer debt levels relative to income actually declined. As predicted, the one exception to this was student loan debt, which is now 40 percent of all consumer (nonmortgage) debt and grew by 4 percent in 2020, while cumulative credit card balances declined by 10 percent.
Industry Earnings Pressure Will Increase
Many financial institutions achieved record earnings in 2019; this may be difficult to repeat in 2020. Others have already started to feel the pressure on earnings. In 2020, there will be more margin pressure and loan losses may begin to creep up. The most recent Fed rate cut of 50 basis points will put downward pressure on asset yields, which will not be matched by a declining cost of funds. Financial institutions will also pay higher wages to attract increasingly scarce talent. All this is likely to put downward pressure on industry earnings. These are natural, cyclical patterns that occur in the business cycle.
Accurate. Although many financial institutions did have record years in terms of asset growth and earnings, in general for the industry there was increased pressure on earnings. The average institution in our Performance Analytics program experienced a 50 percent reduction in earnings per consumer household, almost entirely due to margin compression. Unfortunately, we don’t expect relief from this in 2021, and continued earnings performance will be a function of managing expenses more effectively, on the one hand, but more importantly on building deeper relationships with customers and members in order to grow balances and offset the impact of lower spreads.
Credit Union Purchase of Bank Assets Will Accelerate
One final trend that we feel will continue is the credit union purchase of bank assets. While credit unions cannot technically purchase a bank, they can purchase a bank’s assets and assume its liabilities. There have been 35 of these types of transactions since 2012. This is not a massive trend. It represents less than 2 percent of all bank purchases since 2012, and most of these transactions are smaller transactions. However, it is a growing trend that we expect will continue.
Not accurate. The pandemic put a stop to most merger and acquisition activity in the industry. However, we expect that this M&A activity will make a slow resurgence in 2021.
All in all, for a most unusual pandemic year, our predictions were surprisingly on target.
Your inquiry has been successfully submitted and is now being routed to the appropriate member of our team.