Savannah Chamber

14 8 As things stand, businesses' spending on equipment and intellectual property will provide a good tailwind to US GDP growth. The need to improve productivity and access to inexpensive credit will support such spending, but the combination of COVID-19 and the trade war creates too much uncertainty for capital spending to expand vigorously. Some businesses therefore will not move forward with much needed capital spending. Downside risks include delays in finding a medical solution to the virus, an escalation of the trade war, slower than expected recovery for oil prices, lower stock prices, and possible turmoil in the financial markets. By historical standards, businesses' capital spending has been very weak for an extended period. Consequently, there is a long-term need to increase spending on nonresidential fixed investment despite low levels of capacity utilization. That is because too much of the US capital stock is getting quite old, or is in the wrong industry, or in the wrong location. In recent years, businesses have spent aggressively on stock buybacks and acquisitions, but have not spent aggressively on equipment and other forms of capital that raise productivity. Investments have been deferred for so long that replacement needs will raise capital spending in 2021. Capacity utilization is very low and therefore will be a headwind for business spending for equipment and software. In July 2020, the rate of capacity utilization in all industries was 71 percent, which was up from its low point of 64 percent in April 2020. Nonetheless, the long-run (1972-2018) average rate of capacity utilization for all industries in the US is 80 percent. Because the rate of capacity utilization is well below its long-term average, capacity utilization alone will not spur capacity additions in 2021. Capacity utilization varies by industry, with some major subsectors operating above, or below their long-term averages. For example, in July 2020, capacity utilization for industries producing crude goods was 75 percent, a rate 11 percentage points below its long-run average. Capacity utilization at the primary and semi-finished stages of production was 69 percent, a rate 11 percentage points below its long-term average. Capacity utilization for goods at the finished stages of production was 70 percent, a rate 7 percentage points below its long-run average. Corporate Profits Due to COVID-19, corporate profits fell sharply in 2020, but are expected to rise substantially in 2021. Too a considerable extent, the expectation of a high percentage gain in corporate profits in 2021 reflects easy comparisons to depressed profits reported for 2020. Consequently, earnings per share will not quickly return to pre-pandemic levels. The forecast for 3.5 percent inflation-adjusted US GDP bodes well for a partial rebound in domestically generated corporate profits. Plus, due to poor labor markets conditions unit labor costs are expected to decline slightly in 2021, which is a tailwind for corporate profits. Very low interest rates will help profit margins, especially for debt-heavy and capital-intensive businesses. Expense management and more broadly based – albeit moderate – growth in demand for goods and services will support profits. Cash flow will be stronger and financing should still be reasonably easy to obtain, and as noted above it will be inexpensive. The recovery of housing markets and substantially more single- family homebuilding will boost profits for many home-related industries. Growth in spending for business equipment bodes well for profits earned by technology-oriented companies. Productivity growth is likely to be positive and productivity is a panacea for profits, wages, and the overall economy. On the minus side, slow economic recoveries from COVID-19 in the EU and other developed economies will limit overseas earnings growth. In addition, past appreciation of the dollar will make it expensive for companies to convert earnings in foreign markets to dollars. The dollar's value will moderate only slightly in 2021, which will not provide much help to profit growth based on overseas earnings. Another problem is that businesses' pricing power will not be very strong in 2021. Many companies will resist price increased in order to lure back customers lost during the pandemic. Competition will be intense as companies struggle. Some industries will take a long time to recover from COVID-19 and will not return to profitability in 2021. Air transportation, the cruise industry and movie theatres are a few examples of industries where profits will be elusive, and perhaps for many years. It is also important to recognize that financial institutions' profit margins will be severely constrained by a much flatter than normal yield curve. International Trade Uncertainty about COVID-19 as well as US trade policy and tariffs adds considerable risk to the 2021 forecast for international trade. The Phase One trade deal suggests that trade tensions will not escalate. Indeed, the Terry College's baseline forecast assumes that the US-China trade war does not escalate, but it also assumes that trade tensions will remain very high. In 2021, real exports and imports will grow at about the same pace, but imports and exports of goods will do better than imports and exports of services. The 2021 trade gap will be larger than in 2020.

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