This week, Tom sits down with Joe Keating, Chief Investment Officer for NBC Securities.  They discuss the economic outlook for 2021 and what impact a vaccine and Biden administration will have.


Intro: Helping community bankers grow themselves, their team, and their profits. This is The Community Bank Podcast.

Caleb Stevens: Well, hey everybody. And welcome to episode 18 of The Community Bank Podcast for our goals to help you grow yourself, your team, and your profits. Joining me today is Tom Fitzgerald. Tom, good to see you.

Tom Fitzgerald: Good to see you too, Caleb, hope you’re doing well.

Caleb Stevens: Doing well, you must be one of the busiest research and strategy guys in all of banking. The past couple of weeks with the election and everything going on with that, how’s it been?

Tom Fitzgerald: It’s been a lot to talk about, it’s almost like there’s no shortage of things to write about or to think about. And so, I’m obviously looking forward to the holidays to take a little break from all that.

Caleb Stevens: It’s always good to be joined by another economist, Joe Keating, to help us make sense of all the madness that’s going to be ahead for the economy in 2021. What does the vaccine potentially mean? What does the Biden administration mean? And so that was a great conversation. You just wrapped up with him and I’m excited for our listeners to hear today.

Tom Fitzgerald: I can’t wait for them to hear it too. Joe always has some interesting insights and that’s why he’s such a popular guest on our show.

Caleb Stevens: Well, this will probably be the last economic kind of hard data, show that we’ll have this year. I’m really excited for the next couple of shows because there’ll be a little more focus on leadership and culture. I feel like we’ve been hitting the economy hard, the investment portfolio hard the past few months. It’ll be nice to kind of wrap that up as we look forward to 2021 and then end on maybe a little happier, a little more of an inspirational note.

Tom Fitzgerald: That’s right. Enough of the technical stuff let’s get into more of the culture, like, you said.

Caleb Stevens: It’s good to have a balance though, because when you’re leading the bank your balance sheet matters, but also your leadership matters as well. And you want to hold both together as best you can. So, thanks for joining us today. And we are excited to play Tom’s conversation with Joe Keating right now.

Tom Fitzgerald: Well, welcome back, Joe. This is I think your third appearance for us on our Community Bank Podcast since we started back in April or May. So welcome and how are you doing?

Joe Keating: I’m doing great, Tom, good to hear from you.

Tom Fitzgerald: Well, good. And I think our listeners are excited and want to kind of hear what you have to say. And so, we’ll just dive right into it and give you a shot at this first question here. Two weeks ago, the Bureau of Economic Analysis, and this is the outfit that calculates those GDP numbers that everybody fixates on every quarter, reported the third quarter of 2020, a historically strong number. Of course, that followed a historically weak number in the second quarter. And so, we’ve had quite a roller coaster during the last two quarters. But could you just kind of speak briefly on the highlights of what you saw in the third quarter? And also, how does the economy look today versus where we were, say, pre-pandemic and then also from the report, take a look at what you think are the stronger sectors of the economy and also some of the sectors that are a little bit lagging right now.

Joe Keating: That’d be my pleasure, Tom. Well as the economy started to reopen in May which seem like an eternity ago, doesn’t it?

Tom Fitzgerald: It does.

Joe Keating: Following the lockdown, which started in March, the economy’s growth rate rebounded at a startling 33% annualized rate in the third quarter, following the devastating 31% rate of decline in the second quarter. Now we all know that we tend to look at numbers that are down one or 2% up to 3, 4%. So, these numbers are just clearly outsized as Tom alluded to, on a year over year basis, the economy is 2.9% smaller, the surge in the third quarter took place in a couple of sectors, one in consumer spending across the board. Secondly, in residential construction outlays along with stronger business capital spending on equipment and these combined to power the economy to its strongest, the pace of growth on record exceeding the previous World War II record of 16.7% in the first quarter of 1950.

So, let’s start with the consumer sector, which is the largest sector of the economy at 70%. And consumer spending has two pieces, goods, which are both non-durable goods and durable goods, and then services. While all of the consumer spending’s powered ahead at almost 41% annualized rate led by the spending on goods, which actually overshot pre-COVID levels by almost 7%.

The rebound and goods spending were widespread as motor vehicles gained at over an 87% rate, as there’s less interest in ridesharing and mass transit, as well as air and train travel today, household furnishings at almost a 61% pace part and parcel of what’s going on in the housing sector, recreational goods, and vehicles an excess of 48% and clothing at 161.5%. Now understand the enormous size of the gains in goods outlays will be a one-quarter phenomenon and reflect the severity of the decline in the economy.

During the lockdown. I say it’s going to be a one-quarter phenomenon because we’re back almost 7% above pre-COVID levels after the rebound. Now, if we move over to household spending on services and services by themselves amounts to almost 43% of the economy, they rose very sharply in excess of 38%, but they remain almost 8% below pre-COVID levels as large segments of the service sector remain in partial shutdown or facing reduced demand. So, guess where the growth in the economy is going to come in 2021, it’s going to come in the service sector, strengthened services was found in the reopening of healthcare services at almost a 94% rate, transportation services, 173%, recreational services, at 277% and restaurants and bars at 210%.
As the economy moves towards a more complete reopening next year with the news on the vaccines, consumer spending on services should lead the pickup along with jobs in the service sector, residential construction outlays surged at a pace in excess of 59% as the decline in mortgage rates, boosted affordability and household preference has shifted.

And I’m going to come back and talk about housing more in a moment. Business capital spending rose at a pace in excess of 20%, but the components turned in dramatically different results. Outlays on structures fell at almost a 15% rate as not surprisingly the demand for office and retail space plunged and also energy outlays were very weak, business equipment outlays, however, surged at a pace in excess of 70% with technology spending growing at a 53% rate and transportation equipment surging over 258% as businesses adjusted to the new work at home and delivery trends.

The income data was very distorted by the cares act, which provided income support in the second quarter of the year. However, wages and salaries grew at a pace of almost 22% in the third quarter as employment rebounded. We also saw savings rates remained very high, close to 16% down from almost 26% in the second quarter, but still well ahead of a pace between 7.2 and 7.8% that we saw over the 2017 to 2019 period.

Now going back to housing, it’s the strongest sector of the economy considering that housing starts, which most correlates to residential construction, are always 56% higher than their April low and are higher by 11% compared to a year ago. Existing home sales are 68% higher than the May low and are higher by 21% compared to a year ago. And new home sales are 50% higher than the March low and are higher by a remarkable 32% compared to a year ago. Well, why is that?

Well, the pandemic has reshaped where and how Americans want to live with new work from home flexibility, and record-low mortgage rates have boosted affordability, dense cities, which were hit hard by the coronavirus and the flare-up and social unrest last summer are losing residents to suburbs, exurbs, and rural areas. Additionally, first-time homebuyers are demonstrating new strength as older millennials who delayed getting married and having children are now reaching those milestones, increasing homeownership demand.

Finally, there is still pent-up demand from potential buyers whose purchases were temporarily disrupted by the lockdowns during the second quarter and widespread economic uncertainty in the wake of the pandemic. The pickup and housing demand is spurring demand for furniture, appliances, flooring, renovations, providing a lift to consumer outlets for durable goods that we already covered. Spending more time has increased demand for home entertainment equipment, swimming pools, screen porches, patios, exercise equipment, fancy kitchens, and home offices.

The weakest sector of the economy remains businesses that provide services to consumers as lower densities of people everywhere and less travel will persist for some time. But this will ease over time with the distribution of the vaccines. Restaurants and bars, airlines, hotels, casinos, cruise ships, small retailers, sporting venues, gyms, and salons are still running at much lower levels of activity compared to January and February. Until vaccines are widely distributed, we expect the economy to continue to recover selectively.

Tom Fitzgerald: Without something to look forward to on that service sector side. And I thought it was interesting to Joe on that report, the third quarter, and the second quarter both gave us a little bit of a math lesson in that if you lose 30% and then you turn around and gain 30%, you’re not back to where you were before. You’re still, you’re still in a deficit position. And so, as you said, I think we’re looking at 2020 as being down maybe 4%, something like that from the prior year. So, it’s sort of like your stock when you lose 50% and you have to get a hundred percent to get back to where you were and it just, the math is not your friend in this kind of situation.

Anyway, the economy has certainly had so much thrown at it this year. Obviously, the pandemic was the big item. And then as we moved through the cares act, and then there was talk about a stimulus 2.0, and that still has yet to come to fruition. And then of course the election that’s just passed. So, it’s faced a lot of risks, but in your view, Joe, what is the biggest risk still facing the economy currently?

Joe Keating: Sure. Well, there are a couple of risks, but the good news is that the risks are falling a bit with the development of the vaccine front. But here’s how I look at the economy. A two-track recovery is emerging from the country’s pandemic driven recession. There are the livelihoods of well-educated and white-collar professionals. Businesses tied to the digital economy or supplying domestic necessities and regions that are home to technology forward companies are by and large prospering. The bulk of the newly unemployed are lower-wage workers with fewer credentials and are concentrated in service sector jobs in hard-hit industries like restaurants, lodging, entertainment, retail, consider that the recession was concentrated in a very unique way in individuals that make up to 30 to $40,000 a year, largely represented by women and heavily represented by minorities.

This uneven recovery will further exacerbate long-standing disparities in the economy and the labor market without more targeted government relief for unemployed Americans and hard-hit businesses, cities, and states. Going back to the potential relief package, Tom, that you mentioned before, a key factor in how the economy will perform in the coming months will be the level of income support for the unemployed because the longer the reopening process takes and the lower, the level of income support, the greater will be the rise in bankruptcies and the number of jobs which will be permanently lost. Apart from the course of the virus itself, one of the two short-term risks to the outlook would be the failure of additional Coronavirus Aid to pass the Congress.

For 2021, the wages and salaries data, and the still high personal savings rates are positive for consumer spending. Additionally, the strength in housing and durable goods outlays point to strong consumer confidence while the sharp rise in business capital spending on equipment points to strong business confidence. However, since the economy started to recover in May, the economy has been in a very peculiar position of having one foot in a pandemic and one foot in an economic recovery. The development of vaccines is a game-changer as it will eventually end the pandemic in 2021.

So, there is light at the end of the tunnel. What we do not know is how long the tunnel is, but it seems a reasonable timeframe is the second and third quarters of 2021. We expect a gradual return to normalcy next year, as vaccines are rolled out, hopefully actually starting in December and definitely by the first quarter, during the second and third quarters of next year, that’s when the service sector will pick up speed towards normalcy or full recovery.

We look for the economy to grow between a 3 and 5% pace this quarter, given that we don’t have the relief aid package passed yet, probably going to be closer to 3% than 5%. And if the aid does get passed in January, which is probably the more likely timeframe right now, that’ll push growth into the first quarter of next year, subtracting a bit from what the fourth quarter could have been. For all of 2020, as you mentioned before, the economy should decline somewhere on the order of 3 to 4% but should grow in the range of 4 to 6%, in 2021, the other economic risk beyond the risk of not getting Congress to pass aid relief. As we head into 2021 would be policy mistakes, such as extensive new lockdowns, higher taxes on business, or uncertainty, which slows investment.

So, we look at the pace of growth over the course of 2021 to accelerate as distribution of vaccines proceeds with reported new cases of the virus, hopefully falling to something close to zero by the fourth quarter. The quarterly growth rates in real GDP for 2020 were so distorted by the enormity of the decline in the economy during the second quarter that I like to look at some non-annualized growth figures to add some perspective. For instance, in the second quarter of 2020, the economy was 10.1% smaller than in the fourth quarter of 2019. Now during the entire great recession of 2008, 2009, the economy fell 4%.

Whereas this time around two Q versus four Q smaller, by 10.1%, in the third quarter, the economy was 7.4% larger than in two Q, but still three and a half percent smaller than in four Q 2019. Meaning the economy is still a long way from regaining all the tragic losses of the lockdown months. By the end of the year 2021, the economy should be fully recovered and about one to 2% larger than in the fourth quarter of 2019, depending upon the amount of additional fiscal relief provided by Congress and The White House, and the extent to which the service sector successfully reopens with the distribution of the vaccines next year.

Tom Fitzgerald: And you mentioned a couple of times in there about expecting some kind of a stimulus fiscal plan coming from the government. So, we’re just a couple of weeks removed from the elections. Can you give us some of your take on the election itself, and particularly in the center we’re sitting here? At least I’m sitting here in Georgia, which is going to have a twin runoff on January the fifth, which will really decide the balance of the Senate. So just give us, a little bit, of your big takeaways from the election.
Joe Keating: The eyes of the country are on you guys in Georgia.

Tom Fitzgerald: That’s right.

Joe Keating: Well, we took the position in the months leading up to the election that while the presidential election was obviously important from a policy perspective, the most important election was the Senate as Tom, just alluded to. Assuming that the Democrats would maintain a majority in the house of representatives. Republican control of the Senate was necessary to maintain a divided government, irrespective of who was elected president. The two divided government scenarios represented the best outcomes for common stocks in our view, as both parties’ worst policies would not be implemented.

As Tom alluded to currently the Republicans hold a 50-48 lead in the Senate with the two Georgia Senate seats heading for runoff elections on January five, the strong performance of common stocks during November, the S & P is up roughly 10% on the month so far points to investors expecting at least one Georgia Senate seat remaining Republican.

For the sake of argument, however, let’s cover the scenario where the Democrat party takes both the Georgia seats and Vice President Harris represents a tiebreaker allowing Democrats to essentially control the Senate. There’s a fail-safe for Republicans and moderate conservative investors however, as conservative Democrats, Senator Joe Manchin of West Virginia has stated his intention not to go for any far-left progressive legislative measures that would come before the Senate, under that scenario with all senators voting along party lines, except for Mr. Manchin, who will not vote, the Republicans would prevail on a 50-49 vote.

And I would not be surprised if other conservative democratic senators line up with Senator Manchin to act as a firewall against the far-left progressive legislation in the Senate. What this means is that irrespective of how the Georgia runoff elections play out the far-left progressive agenda contained in the Biden platform will not come to fruition.
This means no significant job-killing tax increases, no green new deal, no Medicare for all, no adding two new States, Washington DC, and Puerto Rico, which would add four Democrat Senate seats, no ending the legislative filibuster in the Senate, which requires 60 votes to advance legislation and no adding justices to the Supreme court. A Biden administration could ramp up a regulatory framework, particularly in the energy and financial services sectors. However, no radical shift in policy is likely to take place as Mr. Biden will be forced to govern from a position of moderation.

Additionally, it seems to us that the main takeaway in the election was that America remains a moderate centrist country that has little general interest in far left-leaning, progressive policies. The Democrats were unable to flip the Senate while Republicans lost no seats, they had to defend in the house and look to have picked up at least 11 seats. On top of that, remember that the party not in The White House generally picks up congressional seats in the midterm elections, which will be here in no time. So, despite what looks like Mr. Biden winning The White House, and I’m not getting into forecasting, how all that’s going to play out. Okay. It’s just that it looks like he’s going to win The White House. Democrats were not able to win the down-ballot elections. Back on November the third.

Tom Fitzgerald: Let’s turn now we kind of talked on the fiscal policy angle with the new government coming in, in January, let’s kind of turn back to the fed. The Fed was quick, and I think did a great job early on in the pandemic with some of the policy moves they did as far as implementing, several programs of emergency lending reinstituting their quantitative easing program. They also course ran rates down to zero and have been pretty, pretty vocal, and pretty transparent on what it would take to get those up again. So, what do you see if 2021, Joe? What do you see for monetary policy coming out of the Fed for next year?

Joe Keating: Well, this is going to be my shortest answer to one of your questions, Tom, the fed just held an FOMC meeting on November the fourth and fifth and consistent with most everyone’s expectations made no change to policy. We do not see the Fed changing policy any time soon. The Fed is absolutely focused on getting the core inflation rate up to 2%. So, they are going to maintain a very accommodative monetary policy for as long as is necessary. Time will tell exactly how long that is, but we think you could have rates held at zero for the next two to three years.
And what is it the feds are going to be watching for, they’re going to be watching for the unemployment rate, getting back under 4%, remember it was three and a half percent in February when the economy was shut down or just prior to the economy being shut down. And that the core inflation rate is running consistently at 2%. So, I think that policy is going to be very unexciting and stable in a good way for the next two years

Tom Fitzgerald: Could be an easy time to be a fed member, right. Just go to the meetings and sit on your hand.

Joe Keating: That’s exactly right.

Tom Fitzgerald: Go ahead and plan their vacations. In light of that, do you have an outlook on treasury yields? What do we see there as far as rates in 2021?

Joe Keating: So back when, and you can remember this very well, Tom, when the, I try to follow the yield on the tenure and it hit 54 basis points back on March the ninth, and again, on July 27. And at the time all of us at center state basically came out and said that’s below we’re not going to break below that 54 basis points and so far, and I’m looking to tap on wood here somewhere, that’s been the case. The yield on the tenure reached 86 basis points by the end of October, it spiked to 97 basis points on November the 10th, following the results of the presidential election and the announcement by Pfizer that its vaccine was 90% effective in late-stage trials. So, if that holds and we think it will, that means that we’re going to exit the pandemic during 2021, which as I’ve talked about before is going to help the service sector of the economy return to some semblance of normalcy.

And we’ll see the pace of economic growth accelerate during 21 as the distribution of the vaccine proceeds. So, taken with the feds major shift on, policy. We think yields on longer data securities, like the tenure will rise as we go through 20, 21, not markedly but I would not at all be surprised the yield on the tenure gets pretty close to 1% as we get to the end of the year. I think today, the yield on the tenure is trading right around 90 basis points compared to that 97 that we saw last week. But I do think the yields will rise, not markedly, but the trend is up.

Tom Fitzgerald: I tend to agree with that, but if it were to get a little bit out of hand, I think the Fed is standing there with their quantitative easing program. And I think they would try to let if they felt like it was getting too much too soon, I think they would be quick to react on that longer in, but certainly, I think you’re right. The bias is towards the upside. As long as the economic numbers keep kind of rolling along as they have been. I would be remiss, Joe, if I let you out of here without asking about the stock market and we’re all sitting on 401ks that have, I think weathered all of the storms of 2020 pretty well and just how do you view the stock market going forward and also into next year?

Joe Keating: Sure. Well, two major developments have come together here in November to push stock prices higher. I already mentioned that stock prices are higher using the S & P on the order of 10% here in the first 16 calendar days of October. And that followed two months of moderate decline in September of October, which I kind of viewed as basically a buyer’s strike as the presidential election was looming. And new cases of COVID-19 ramped up, which ultimately hit a series of new daily records. Investor sentiment, this month has been lifted by prospects of continued divided government in Washington, as I’ve already covered.

And the announcement by Pfizer last week and Alma derma today that the vaccines for COVID-19 were 90 and almost 95% effective in late-stage trials, clearly the best news of a rather dismal 2020. We expect common stock prices to be higher a year from now as the distribution of vaccines boosts, the pace of economic activity as 2021, wears on, as I’ve talked about, particularly in the service sector, gridlock in Washington means large increases in corporate income taxes and corporate gains taxes are unlikely as well as runaway spending on progressive policies that are contained in the Biden platform are equally unlikely.

Congress will hopefully come to an agreement on another relief package for the more than 9 million additional unemployed individuals currently compared to February. Remember, these folks are unemployed due to nothing that they did. It’s all because of what the government did to shut down the economy with 75% of the S & P 500 companies reporting for the third quarter, operating earnings are twelve percent lower versus a year ago, but if you go back to July one, the start of the third quarter Standard and Poor’s analysts were expecting the decline in the third-quarter earnings to be over 22% so third-quarter earnings are outperforming expectations.
Earnings are expected to grow close to 40% over the four quarters of 2021 compared to 2020. And we always say that there are two keys to the outlook for stock prices, the T1, the number one being earnings, and the second being federal reserve policy. And we’ve already talked about the fact that the federal reserve is committed to a very accommodative monetary policy for the foreseeable future.

Tom Fitzgerald: Well, Joe, I really appreciate your time today. And I know, like, I said, this is the third time we’ve had you. And we would love to have you back as the calendar turns into 2021 to kind of see how the economy’s looking, with a new government installed and as we get through, and like, you said, get those vaccines going and get people back out there, feeling more comfortable about being out and getting close to back to normal. That may take a while, but hopefully, it’ll get here sooner than we expect. But again, Joe, thank you so much for your time, really appreciate it.

Joe Keating: You’re welcome, Tom. Great to talk to you.

Tom Fitzgerald: We’d love to have you back. So, take care.


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