Why producers can expect a return to normalcy in 2021

Relief is in sight.

Battered by the pandemic and scrambling to shore up finances, businesses can look forward to an easing of the pain over the next 12 months. Economists anticipate a gradual but noticeable recovery fueled by a surge in corporate profits, a strong housing market and the successful rollout of a vaccine.

“The COVID-19 recession is over, and the economy is currently in an early-cycle expansion,” says Sophia Koropeckyj, managing director of industry economics at Moody’s Analytics, a research firm based in West Chester, Pennsylvania.

The healthier the economy, the better for business profits. And Moody’s expects the nation’s GDP to increase at a 2.6 percent clip for 2021. That’s a welcome rebound from the previous year’s decline, expected to come in at 4.9 percent when figures are finally tallied.

Faster economic growth, Moody’s says, should in turn help boost corporate profits by an expected 17.6 percent in 2021 – a dramatic turnaround from the 11.3 percent decline of the past 12 months, and reason for optimism about a return to the aggressive capital expenditures so critical to an economic rebound.

Slow and steady

For most businesses, the return to normal should be gradual. During the first half of 2021, households will continue to self-quarantine as a wave of bankruptcies boosts the number of permanent job losses.

By summer, Koropeckyj says, things should look different.

“The economy will regain its stride in the second half of the year, when a vaccine or treatment is assumed to be widely available,” Koropeckyj says.

Business owners seem to share Moody’s optimistic mindset.

“Even though there’s still a lot of uncertainty out there, many companies have a positive outlook,” says Tom Palisin, executive director of The Manufacturers’ Association, a York, Pennsylvania-based regional employers’ group with more than 370 member companies. “Maybe they’re being overly confident, but our members seem to feel that in six months’ time things will have turned around significantly.”

With its diverse membership, the Pennsylvania trade group can be viewed as a proxy for American industry. The organization’s members report results that seem to position the tail end of 2020 as something of a springboard for future months.

“Conditions for our members have improved, with increasing revenues, since the April and May timeframe,” Palisin says.

Springboard or not, it’s a sure bet that few businesses will regret seeing 2020 in the rearview mirror.

“It’s been a rough year for many manufacturers,” Palisin says. “We’re looking at pretty significant revenue declines of 30 to 40 percent through much of the year for many of our members, who have had to do furloughs and layoffs to maintain operations while dealing with supply-chain problems.”

Palisin acknowledges that the road ahead will be rocky for many operations. That’s especially true for those with limited resources.

“Smaller companies aren’t as well equipped as far as financing and cash flows to weather an economic downturn,” Palisin says. “Things have been significantly tougher for them.”

Housing surges

An important driver for the economy at large, residential construction is doing extremely well and promises more good news in 2021.

“Housing demand has bounced back thanks to very low mortgage rates and the release of pent-up demand,” says Koropeckyj, who points to healthy builder confidence as the nation enters the new year.

The road ahead looks sunny indeed: “We forecast housing starts will surge by 20.1 percent in 2021, after falling an expected 5.7 percent in 2020 due to the initial impact lockdown orders had on construction,” Koropeckyj says.

The comparable 2019 figure was a positive 3.8 percent.

Median prices for existing homes are also increasing at a healthy rate, expected to top 3.6 percent when 2020 figures are finally tallied – not far off the 5 percent increase of the previous year. One key reason: tight supply.

“Housing has been a seller’s market with low inventory levels as homeowners have been reluctant to offer their residences up for sale for fear of contracting the coronavirus,” Koropeckyj says.

The industry itself has engaged in practices that have contributed to its success.

“Real estate professionals have done a great job adapting to social distancing, and enabling the buying and selling of homes, appraisals, title insurance policies and closings at the same pace as before the pandemic,” says Bill Conerly, principal of his own consulting firm in Lake Oswego, Oregon. “With the shift to suburban living, more new homes will be built.”

Despite its recent success, the housing industry faces its own headwinds.

“We expect prices to fall by 1.2 percent in 2021 as foreclosures mount due to an unwinding of forbearance measures by the federal government and private lenders,” Koropeckyj says. “According to the latest Senior Loan Officer Opinion Survey, banks have tightened standards across all sorts of mortgage products.”

And the housing sector faces other issues that will sound familiar to anyone who has watched the industry over the past several years.

“Construction costs are rising quickly, and builders are still grumbling about the inability to find buildable lots and skilled labor,” Koropeckyj says.

As for construction of nonresidential buildings, the bag is equally mixed.

“Although office and retail construction will be soft in the near future, they account for less than one-fourth of private nonresidential construction,” Conerly says. “The big categories of power production, manufacturing, health care and warehouses should do fine in the transition to post-COVID business.”

Strong retailers

Retailing tends to reflect and invigorate the nation’s economy, and this is a sector that has registered notable gains that promise to continue.

“Our current 2021 forecast is for 6.2 percent growth in core retail sales,” says Scott Hoyt, senior director of consumer economics for Moody’s Analytics.

That forecast represents a substantial improvement over 2020, when the 2.6 percent increase expected when numbers are finalized represented a deceleration from the 3.9 percent growth clocked in 2019.

The positive growth rate for retailers in 2020 has come about as consumers have rechanneled their purchasing away from services and toward merchandise.

“While consumer spending has been hammered pretty badly, retailers have not been hit nearly as hard as service businesses,” Hoyt says.

Moody’s forecasts a decline of 6.5 percent in services spending when 2020 numbers are in – a stark reversal from the 4.3 percent gain in 2019.

“Because of people’s hesitancy to travel, to go to entertainment facilities, and to do things with other people, to a certain degree they’re replacing such activities with buying goods,” Hoyt says.

The positive retail reports will come as a surprise to anyone who’s encountered the long rows of shuttered storefronts in America’s cities and towns. Two reasons account for the disparity: The first is the increasing purchase of merchandise through digital channels – a long-term trend that has only been exacerbated by the stay-at-home nature of the pandemic. The second is that consumers have become highly selective, abandoning many merchandise categories in favor of a select few that are either essential to living, or which enhance the enjoyment of pandemic-enforced leisure time.

Both trends merged to create a retail environment that favors some sectors and decimates others.

Capital investment

Despite the strength of housing and retailing, the economy will face headwinds in 2021.

Not least among them is the sluggish state of capital investment. Corporate decision-makers, faced with uncertainty, are reacting in a predictable way: keeping their powder dry. By the end of 2020, total real fixed investment had fallen by 27 percent annualized, according to Moody’s Analytics.

“In uncertain times, investors hold onto cash and delay investments,” says John Manzella, a consultant on global business and economic trends in Amherst, New York. “This undoubtedly puts downward pressure on economic growth. As a result, uncertainty has become the enemy of prosperity.”

More robust investments in commercial buildings and machinery are not expected to arrive any time soon.

“Low-capacity utilization and still-high uncertainty will make expansion decisions difficult, though the declining cost of corporate borrowing will provide some offset,” Koropeckyj says. “Major segments of investment will be weak, with transportation equipment and structures especially hard-hit.”

Structures investment is expected to decline by more than 20 percent in the months ahead, led by the collapse in retail and reduced demand for office space.

Bank loan availability poses one barrier to a rapid return of capital investment.

“While interest rates are low, many companies have taken financial hits that can affect their ability to qualify for loans,” Palisin says. “With corporate financials changed so drastically from the prior year, there is some tightening of access by lending institutions.”

Moody’s identifies technology as one bright spot in an otherwise shadowed capital investment picture. Palisin concurs with the observation, reporting an increase in spending by his members to boost efficiencies.

“The pandemic will probably accelerate the trend toward more automation and robotics,” he says. “Such technology will be needed to increase manufacturers’ resiliency.”

Consumer confidence

Spending by consumers accounts for some 70 percent of economic activity, and it is arguably even more important than capital investment for the nation’s overall business health.

Household spending, though, is driven by public psychology, and the most recent reports from Moody’s Analytics show that the nation has a lot of catching up to do: By late 2020, consumer confidence was running as low as it was in March and April during the worst days of the pandemic.

If uncertainty about the course of the pandemic and the availability of a reliable vaccine are reason enough for high anxiety, there’s a more immediate driver of consumer discontent: the noticeable drop in take-home pay over the past year.

“Wage and salary income, including the value of benefits, is forecast to decline 2.2 percent when 2020 numbers are finalized,” Hoyt says.

Those numbers represent a reversal in fortune from the 4.4 percent increase of 2019.

Pandemic-related furloughs and business closings accounted for a major portion of wage declines. Moody’s expects the unemployment figure to come in around 9.5 percent when 2020 numbers are finally tallied. That’s a precipitous fall from the robust 3.5 percent level consumers were enjoying as recently as February 2020.

Consumers might improve their outlook if the unemployment picture were brightening. Yet the expectations here are, once again, for only gradual improvement. The unemployment rate is expected to decline to 8.1 percent by the end of 2021.

“The labor market will not recover all COVID-19-related job losses until the second half of 2023,” Koropeckyj says.

A brightening jobs picture should translate directly into a boost in take-home pay. Moody’s anticipates 2021 wage increases to come to 1.1 percent – a level high enough to allow shoppers to exhale but too low to spark rapid spending. Hoyt’s expectations for improvements in the public psychology are suitably conditional.

“We are assuming a slight upward trend in consumer confidence until we get a vaccine or an effective treatment, at which point it will probably move up faster,” Hoyt says.

Tight labor

Conditions in the labor market are also preventing a faster recovery. Not only is the unemployment level high, but employers are not finding the job applicants they need.

“Companies are having problems recruiting and getting folks to apply for work,” Palisin says. “Some things going on in the labor market are probably contributing to that. First, the portion of the workforce still on furlough will probably not take another job but will return to the one they were furloughed from. Second, there are childcare issues as students go back to school online, and it’s difficult for those people to get back into the labor pool. Finally, there is some level of health concern by employees going back into the workplace, especially if they are older workers or higher-risk people.”

While the future of the labor market remains unsettled, the opening months of 2021 might provide clues as to whether hiring difficulties will continue.

“Perhaps as we get into the new year people will start to feel more comfortable returning to the workforce, the childcare issues may be resolved, and a vaccine will be developed,” Palisin says. “But right now there seems to be a lot of hesitancy in the labor pool. People are sitting on the sidelines to see what is going to happen.”

Competition for quality workers makes the hiring process all the more difficult.

“Some sectors of the manufacturing economy, such as the food and automobile industries, are hiring quite a bit,” says Palisin. “And sectors such as construction and healthcare are competing with manufacturers for workers.”

New deal

In the opening months of 2021, some key indicators should offer clues to how the year will turn out. Palisin feels the level of durable goods orders may signal the economy’s trajectory, as will the level of capital expenditures.

“Businesses will be looking for increased certainty on matters such as market stabilization, the ability to hire, access to a qualified labor pools, and workplace safety protocols,” he says. “It would be good to have some kind of resolution around trade issues, as well. All of those concerns will be front-burner ones.”

As for the view at Moody’s Analytics, Koropeckyj looks to consumer sentiment levels in early 2021 for insight into how freely shoppers will spend the rest of the year.

“We will also look closely at the number of business bankruptcies,” she says. “And the core unemployment rate, which excludes temporary layoffs, will gauge how much joblessness is attributable to permanent layoffs, which leave behind long-lasting scars on the labor market.”

But perhaps the best economic indicator of all will be the rate of progress toward a cure for the not-so-hidden elephant in the room: the pandemic.

“Businesses will be concerned about the timeline of a vaccine,” Koropeckyj says. “The path toward some semblance of economic normality hinges upon its development and widespread distribution.”

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Supply chain woes

Businesses are facing a familiar challenge carried over from the pre-pandemic world: supply chain fragility.

“Trade disputes are still a problem that has not been resolved,” says Tom Palisin, executive director of The Manufacturers’ Association, a York, Pennsylvania-based regional employers’ group with more than 370 member companies. “The hope is that there’s some kind of trade deal with China. Higher tariffs don’t help in the middle of an economic slowdown.”

The pandemic has made the situation more severe.

“In the worst of the COVID-19 lockdown nothing was coming out of China,” says Bill Conerly, principal of his own consulting firm in Lake Oswego, Oregon. “That only exacerbated the problem of time lags for foreign-sourced goods.”

So far, Conerly adds, few companies seem to be making radical shifts in their sourcing, due to a natural hesitancy to change suppliers. But there is growing pressure to obtain materials not only from domestic suppliers but also from multiple factories.

Another effect of recent supply disruptions may be the building of inventories to higher levels.

“Companies should no longer rely on just-in-time inventory strategies, which too often have become just-too-late failures, and stockpile more supplies both in the United States and abroad,” says John Manzella, a consultant on global business and economic trends in Amherst, New York. “This approach reduces efficiencies but favors risk reduction.”

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