The Year Ahead

8 forces shaping equipment finance and the U.S. economy in 2021

Following a year of decent economic growth in 2019, the U.S. economy fell off a cliff due to the global pandemic in 2020. COVID-19 led to a broad shutdown of the economy beginning in mid-March, triggering a brief but extremely deep recession in which 22 million jobs were lost in a matter of weeks and the economy contracted at the sharpest rate in U.S. history. Equipment and software investment was not immune to the collapse, falling more than 28% (annualized) in Q2. Most states began to reopen over the summer, resulting in the rapid recovery of roughly half the jobs lost in Q2 (in part due to a timely and massive fiscal intervention through the CARES Act). As a result, the economy expanded at a record pace in Q3, and equipment and software investment followed suit, surging 47% (annualized).

While the record expansion in Q3 was not sustainable, the economy continued to expand in October and early November, boosted by surprisingly solid consumer spending even as COVID-19 cases remained elevated. By late fall, however, it was clear that the United States was the new epicenter of the pandemic, and as states and localities reimposed restrictions on business activity, the economy predictably suffered. While Q4 data are not yet available, in the recently published 2021 Equipment Leasing & Finance U.S. Economic Outlook (jointly produced by the Equipment Leasing & Finance Foundation), Keybridge projects that the economy contracted 3.5% in 2020, the worst year since at least WWII. Equipment and software investment fared slightly better, falling 2.9% overall but demonstrating resilience during the second half of the year.

In 2021, we expect the economy to be once again a tale of two halves. The first part of the year will be determined largely by our ability to contain the pandemic while also remaining open for business. This is likely to be a tall order, though the success of the CARES Act demonstrates that Congress has the ability to make a real difference by providing timely and targeted aid to the most affected individuals and businesses. The package passed in late December should help significantly, though additional targeted support could be needed before vaccines are widely available.

In 2021, we expect the economy
to be a tale of two halves, with the
outlook for the second half
of the year brighter.

However, the outlook for the second half of the year is brighter. Several vaccines have entered production and could provide a substantial boost to economic activity once they are widely available, which we expect will occur by late summer. The production and distribution of a vaccine has the potential to unlock a surge in consumer spending once Americans feel comfortable in public again — though there remains a risk that structural damage done to the labor market via permanent job losses may hold the recovery back.

Here are the eight predictions and trends that we believe will shape the equipment finance industry and the U.S. economy this year.  

1. The pandemic will get worse before it gets better, hampering the economy in early 2021.

Entering the year, the third wave of the pandemic that began in mid-October was still rising, leading to crowded hospitals and thousands of additional deaths per day. In response, state and local officials across the country reinstituted operation restrictions on many businesses in an attempt to slow the virus’s spread, protect public health and avoid overburdening local health care systems. Unfortunately, the timing wasn’t ideal: the virus was already spreading widely before tens of millions of people traveled to visit family for the holidays, and with colder weather businesses in many parts of the country are less able to operate outdoors. The combination of these factors is likely to slow economic growth in the first quarter. Federal policymakers likely mitigated some of the potential economic damage by extending and/or recapitalizing key relief measures, including unemployment insurance programs, eviction and foreclosure moratoria, and the Paycheck Protection Program. Whether this relief will be sufficient (and sufficiently timely), however, remains to be seen.

2.  Vaccines will provide relief in the second half of the year and should spur faster growth. 

The single most important factor to watch for in 2021 is the vaccine rollout. While vaccines initially will be targeted to health care and other essential workers and high-risk populations, we expect broad distribution to the general public will begin in the late spring or early summer. Assuming vaccines are as safe and effective in a real-world setting as the test data suggest (and assuming most people who have not yet contracted COVID-19 are willing to be inoculated), the upside potential for economic growth later in the year is substantial. In 2020, consumer mobility and spending patterns tracked closely with local prevalence of the coronavirus, so as the public develops trust in the vaccine and more Americans are immunized, we expect consumption patterns will normalize. Moreover, if the vaccine is widely available by the summer, the potential for a surge in economic activity due to pent-up spending—particularly among higher-income households who had abnormally high savings rates in 2020—provides further upside growth potential. 

3.  Equipment and software investment will start strong but soften as the year progresses.

Like the overall economy, equipment and software (E&S) investment was weak in 2020 overall, driven by a 9% annualized decline in Q1 and a 28% cratering in Q2. However, E&S investment bounced back in Q3 at a record 47% annualized pace, outperforming the broader economy as firms across the country invested to adapt to the new “COVID normal.” The pandemic upended the way that millions of Americans live, work, and socialize and required many businesses to reconfigure business operations. This trend is likely to continue in 2021, providing a sustained boost to E&S investment in the first half of the year, and the propensity to finance this investment should remain elevated. However, we expect that the tailwind effect will wane as the year progresses, and quarterly investment may soften (though remain positive).

Industry leaders should revisit
what higher inflation would mean
for their business. 

Looking at specific industries, the Foundation/Keybridge Equipment & Software Investment Momentum Monitor suggests broad-based investment growth, with all 12 of the tracked verticals exhibiting strong positive momentum heading into the year. We are particularly optimistic about medical equipment investment, which should benefit from vaccine distribution and resumption of elective medical procedures. Construction equipment and trucks should also bounce back, with the former benefitting from increased demand for single-family homes and the latter from over-the-road transportation demand as consumer spending strengthens throughout the year.

4.  Independents will see opportunities to increase market share as financial institutions pull back.

Relief measures, such as eviction and foreclosure moratoria and debt deferral and forbearance programs enacted by federal policymakers or offered voluntarily by lenders, undoubtedly saved the U.S. economy from a longer and deeper recession. However, these measures also made it harder to determine the creditworthiness of many borrowers, exacerbating the typical post-recession trend of tighter credit and a “risk off” posture. In 2021, we expect banks to continue to exercise caution in financing equipment expenditures, which should provide increased opportunity for independent lenders and lessors to capture additional market share.

5.  Massive stimulus and pent-up demand mean that inflation could surprise to the upside.

While Congress appropriated trillions of dollars toward pandemic and economic relief efforts in 2020, the Federal Reserve injected trillions more into the financial system to stabilize it. Together, these actions caused a massive increase in the money supply, which is now more than 25% higher than its year-ago level. Due to reduced economic activity and low oil prices (among other factors), there has not yet been a commensurate increase in inflation. 

However, the story could be different this year. If vaccines are as safe and effective as advertised and widespread distribution is achieved by the summer, the increased spending on travel, meals and other services could drive prices higher. Though we do not expect a large inflation spike, inflation could certainly end the year in the 2.0–2.5% range. As such, industry leaders should revisit what higher inflation would mean for their business, including lower yields, particularly for contracts with longer time horizons.

6.  The Trump Administration’s hard line on China is unlikely to soften under the Biden Administration.

One of the defining policies of the Trump Administration was a hard line on almost all things China. President Trump’s confrontational policies against China included (1) imposing tariffs on Chinese goods to combat what was perceived as unfair terms of trade, (2) encouraging allies to cut Chinese telecom firms out of their next-gen cellular networks and (3) imposing sanctions on Chinese officials in retaliation for human rights abuses.

Construction equipment should
bounce back, benefitting from increased
demand for single-family homes.

 

Though some of these policies were controversial, the reality is that the American public’s opinion of China has soured notably in recent years, across the political spectrum. As a result, it has become increasingly politically untenable for President Biden to roll back some of the actions taken against China. While the Biden Administration is likely to favor a return to a pre-Trump foreign policy posture on many issues, we do not expect this to occur with China, where in many respects the genie is out of the bottle. Instead, U.S. / China relations are likely to grow more complex as China continues to challenge the United States’ economic and political dominance.

7.  The Georgia Senate races were important, but likely less consequential than many believe. 

Though the runoff races in Georgia were the focus of a huge amount of attention given that they resulted in a 50-50 tie that nominally flipped control of the Senate to Democrats, the reality is that most of the more controversial policies favored by House progressives (e.g., the Green New Deal) will almost certainly not come to pass. This is because Democrats simply do not have the votes to enact them given that they will need the support of political moderates in conservative states, most notably Joe Manchin of West Virginia. While a larger majority could have put the Senate filibuster in jeopardy and paved the way for a more aggressive legislative agenda, the narrow margin will make Sen. Manchin (who has been clear in his opposition to removing the filibuster) among the most powerful men in Washington. The man who famously shot a bullet through the cap-and-trade bill during his 2010 reelection campaign is, to put it mildly, unlikely to support the Green New Deal. Moreover, assuming Republicans remain united against President Biden on most issues, other policies favored by progressives may face a similar fate if even a single Democratic moderate (e.g., Kyrsten Sinema, John Hickenlooper, Jon Tester or Mark Warner, just to name a few) opposes it. We do expect Democrats to take full advantage of the reconciliation process in the Senate to push for legislation with a simple majority vote, but a sharp leftward legislative turn is highly unlikely given their tenuous majorities in both chambers.

8.  Infrastructure investment could be a rare opportunity for bipartisan agreement.

Beginning with an impeachment trial and ending in a heavily contested election that made history both for its voter turnout and, ensuing court battles—and siege on the U.S. Capitol building—with a heavily politicized pandemic somehow sandwiched in between, 2020 was one of the most polarizing years in memory. Although Congress was able to come together and reach several deals when it mattered most to enact COVID relief measures and avoid a complete collapse, the issues for which there is a realistic hope of bipartisanship are few and far between. 

However, one such issue is infrastructure investment, and we believe that this could finally be the year in which Democrats and Republicans come together to pass a major infrastructure package. There is broad-based agreement that additional federal investment is needed for urban highways and transit systems, and for extending broadband internet to underserved rural communities (among other priorities). Though discussing the prospects of an infrastructure deal sometimes makes us feel like Charlie Brown on his run-up to Lucy holding the football, infrastructure could be a rare spot of common ground. Time will tell, but a major investment bill that funded infrastructure priorities in both blue and red states while simultaneously tackling high unemployment seems like a real possibility.