The U.S. Bureau of Economic Analysis (BEA) released its Q2 2020 report on the US economy in the midst of the pandemic recession (see Gross Domestic Product, 2nd Quarter 2020 (Advance Estimate) and Annual Update). The economic damage was even worse than we or other forecasters had projected. Real GDP fell at an annualized rate of 32.9% — a shockingly large decline.
On a year-over-year basis, the US economy dropped by a still sizable 9%. The decrease was broad-based and included annualized drops of 35% in personal consumption; 30% in business investment; 39% in residential investment; and 5.6% in state and local government spending. In consumer spending, healthcare services, transportation services, recreation services, and food services and accommodation were 40% to 50% below the level in Q4 2019. But contrary to our expectations, spending on automobiles and recreational goods and equipment rose from Q1 2020. That pattern clearly reflected a consumer response to the pandemic and business closures: “If we can’t go on a vacation or travel to Disneyland, let’s buy a boat or a bicycle or an RV” or “If we’re worried about taking a train to commute to work or a plane to visit the folks, let’s buy a car instead.”
But US tech investment held up surprisingly well. On the same annualized basis, business investment in computer equipment actually rose at a 71.2% rate, communications increased at a 3.8% rate, and software decreased at a mere 1% rate. The actual increases in dollars were more modest. For example, quarterly investment in computer equipment increased by about $4 billion from Q1 2020 to Q2 2020 and in communications equipment by $0.3 billion. These investments were clearly related to the efforts of US CIOs to support the sudden shift of employees to working from home instead of in offices.
Looking ahead, here are the implications of this GDP report for the economy and the tech sector:
- Such a big drop in real GDP in Q2 2020 sets the stage for what will look like an impressive rebound in Q3 2020 . . . It would not be at all surprising if the real GDP annualized growth rate in Q3 2020 is in the 15% to 20% range. Improvements in business investment, residential investment, and consumer spending on healthcare services and nondurable goods spending would lead that rebound.
- . . . but the economic recession will not be over and may well get worse. A 15% annualized jump in US real GDP in Q3 2020 would still leave the US economy 5% to 7% below its level at the end of 2019. Moreover, the spread of COVID-19 to the South and West and the resulting pullbacks in consumer activity and business shutdowns will mean some areas of strength in Q2, such as auto and recreation equipment, may drop in Q3. Various indicators of consumer activity, such as Apple Maps route requests or OpenTable’s seated dining requests, saw renewed weakness in July after recovering in May and June. The prospect of an end to or reductions in the extra unemployment benefits in August will be a big negative, as would a failure to provide federal support to strapped state and local governments and education providers. The outcome of the current battle in the US Congress between the House’s $3 trillion economic stabilization and the much more limited Senate Republican proposals of around $1 trillion will be a big factor in determining whether the US economy has a solid 15% annualized upturn in Q3 2020 or a weak 5% to 10% bounce.
- The pickup in computer and communications equipment investment will most likely be reversed. The work-from-home arrangements that were thrown into place in April have proven adequate to the task, so CIOs are unlikely to spend more. Instead, we think layoffs and concerns about the future business outlook will lead to sharp cuts in these categories in Q3 and Q4.
- The weakness in software investment is likely to be a precursor to further declines. The 1% annualized decline in software investment reflects the growing role of cloud software in the US software budget. As we have noted in earlier blogs (Forecasting In Uncertainty: Warning Signs Inside The SaaS Vendors’ Recent Earnings Reports and Forecasting In Uncertainty: Are Software Vendors Too Optimistic, Or Are We Too Pessimistic About The Software Market Outlook?), cloud software creates a “stickiness” in software spending that makes it hard for clients to cut these costs as easily as they can cut hardware costs. Still, both the BEA data and the software-as-a-service (SaaS) vendor data showed little or no quarter-to-quarter growth in software spending in Q2. That pattern is likely to hold in Q3, especially if Q3 GDP data shows a solid recovery. But a weak rebound in Q3 real GDP would be evidence that the recession has spread to more and more sectors of the economy, including to industries such as financial services, government, healthcare, high tech, and professional services that are big buyers of software.