The Headline GDP Number Masks a Strong Economy The economy grew 1.6% in the first quarter, after adjusting for inflation. This was well below expectations for a 2.5% increase, and significantly below the 3.4% increase we saw in the last quarter of 2024. It also ended a streak of growth above 2% for six consecutive quarters. So, what happened – is growth really slowing down, and should we worry? Simply put, no. As with all macroeconomic data, you always want to look under the hood. Underneath the hood of GDP you find 5 major components: Household consumption Investment – both nonresidential and residential Government spending Change in private inventories Net exports (exports minus imports) The last two, private inventories and net exports, tend to be the most volatile pieces of GDP growth. Excluding these gives us a much better picture of actual spending and production in the economy, i.e. final demand after adjusting for inflation. Think of it like “core GDP.” Real final demand rose at an annualized pace of 2.8% in Q1, well above the 2010-2019 average pace of 2.4%. In fact, government spending eased in Q1 as federal nondefense spending fell, and state/local government investment pulled back. Excluding government spending from final demand, real private final demand rose 3.1% in the first quarter. That’s strong, no two ways about it. In fact, while last quarter’s GDP number is a lagging indicator, the most useful part of the report in terms of looking ahead is final demand. Right now, there’s not much sign that it’s slowing. The table below shows a breakdown of GDP growth by the major groups I mentioned above. Some highlights: Consumption eased, but mostly because households purchased fewer vehicles and less gasoline (in real terms). Services spending accelerated at the fastest pace since the third quarter of 2021 (when it was fueled by the pandemic recovery). Investment spending picked up, with tech and industrial equipment spending accelerating. Residential investment (housing activity) added the most to GDP growth since Q4 2020. You can see how the change in inventories and net exports were a big drag, pulling GDP growth lower by 1.21%-points when combined. Net exports were driven down by a surge in imports, as American households and businesses bought a lot more stuff from abroad than they did in the fourth quarter of 2023. Here’s the Big Picture As I pointed out above, economic growth remains strong when you consider the most important parts of the economy – household consumption, investment, and yes, even government spending. What’s amazing is that the economy has grown at a faster pace than the Congressional Budget Office (CBO) forecasted in January 2020. After adjusting for inflation, the economy is almost 1% larger than the CBO had projected. That’s despite 1) a worldwide pandemic, and 2) the most aggressive rate hike cycle by the Federal Reserve in 40+ years. Of course, a strong economy means inflationary pressures are stronger, and we saw some evidence of that in the first quarter, which indicates that interest rates are likely to stay higher for longer, as I wrote in a blog last week. Stronger economic growth plus more inflationary pressures means the economy is growing quite rapidly in nominal terms (that is, before adjusting for inflation). That’s important because nominal GDP growth is ultimately where profits come from (the same blog linked above discusses how this happens). Nominal GDP growth rose at an annualized pace of 4.8% in the first quarter, much faster than the pre-pandemic trend of 4.0%. The underlying numbers point to a continuation of this above-trend pace. That’s positive for profit growth, which is ultimately what matters for markets over the long run.
Underlying Economic Growth Is Strong, and Here Are 5 Reasons Why Headline GDP growth in the first quarter disappointed, but as I pointed out yesterday, underlying growth was actually quite strong. The good news is that the cyclical areas of the economy, namely housing activity and business investment, are seeing strong growth despite the hurdle of higher interest rates. That’s really icing on the cake. The workhorse of the US economy remains the consumer, and there’s really not much sign of a slowdown as far as household spending is concerned. In fact, services spending, which makes up 45% of the economy (more than twice as large as goods spending) rose at an annualized pace of 4% — above the 2010-2019 trend of 1.8%, and the fastest pace in since the third quarter of 2021. Back in 2021, strong services spending was driven by everyone rushing out to spend once Covid looked to be in the background. That’s not the case now. The current strength of consumption is directly related to the strength of American household finances. Let’s walk through these. Incomes Are Growing Faster than Inflation There’s no question that inflation ran hot in the first quarter, which is a setback after the downtrend in the second half of 2023. The Federal Reserve’s preferred inflation metric, the personal consumption expenditures index, rose at an annualized pace of 4.4% in Q1. But here’s the big picture: income growth is outpacing inflation. Disposable incomes grew at an annualized pace of 4.8% in Q1, but that’s also being pulled lower by falling income from assets (like dividends). More importantly, employee compensation surged by 7.3%. That’s the simplest explanation for why consumption continues to run strong. Average Hourly Wages Are Growing Faster Than Inflation The charts above showed aggregate income growth, or total income across all workers, but that has been helped by an increase in the number of workers. However, inflation-adjusted hourly wages are growing even when you look at the average worker, and separate non-managers from managers. Since the pandemic started, average wages for non-managers have grown faster than the pre-pandemic trend, after adjusting for inflation (green line in the chart below). Over the last year it’s up 1.5%, above the pre-pandemic trend of 1.3%. Interestingly, wage growth for managers has fallen behind inflation since the pandemic, but the good news is that it’s been picking up recently, as the yellow line shows. Over the last year, inflation-adjusted wage growth for managers is up 1.2%, matching the pre-pandemic trend. Keep in mind that non-managers typically tend to spend a greater proportion of their incomes from wages. Household Balance Sheets Are Strong Rising stock prices and home prices have resulted in more wealth for American households. At the same time, liabilities – especially mortgage debt, but also personal loans – have not increased at the same pace, especially relative to disposable income. At the end of 2023, household net worth was 736% of disposable incomes, well above historical levels. That’s on the back of asset values running at 836% of disposable income, even as liabilities stay at 100% of disposable income (in line with what we’ve seen in the past). This is a big reason why the savings rate has fallen since the pandemic. Savings rates averaged 7.4% in 2019, but it’s averaged 4.2% over the past year (through March). In fact, the savings rate has fallen from 5.2% in March 2023 to 3.2% last month. This is not surprising considering net worth is higher. Why save more if you’re worth more? Households Are Far Less Leveraged The chart above is on an aggregate basis, i.e. across all households in America. A typical question we get is, “How does the picture look outside of the wealthiest groups, considering we have a lot of inequality”. Turns out the picture looks good. Across all income groups, liabilities as a percent of assets are well below what we’ve seen historically. In short, households are significantly less levered than in the past. What matters when we talk about household debt is really the proportion of income that goes toward servicing that debt. Household debt service payments are running at 9.8% of disposable income, slightly below pre-pandemic levels and well below the historical average of 11.2%. The Labor Market Is Strong The labor market is the entire ballgame as far as the consumer is concerned. If the labor market deteriorates, incomes fall, consumption falls, and the economy is in trouble. But we have the opposite now. Payroll growth has averaged 266,000 in the first quarter and the unemployment rate has remained below 4% for 26 straight months (the longest streak since the late 1960s). Historically, weekly unemployment claims have been a leading indicator for labor markets. Initial claims for benefits tell you whether layoffs are increasing, while continuing claims for benefits tell you how hard it is for laid off workers to find jobs. Seasonal adjustments due to pandemic-related distortions have been a big problem with claims data lately.To get around this, I compare non-seasonally adjusted data for 2024 to corresponding weekly data in 2023, 2022 and the 2018-2019 average. The top panel in the chart below shows that initial claims continue to run low. They’re comparable to what we saw in 2023, 2022, and in 2018-2019, indicating companies are not laying off too many workers. The bottom panel shows continuing claims for benefits normalized by the size of the labor force – this is the “insured unemployment rate.” You can see that it’s about 1.2% now and running higher than in 2022 when the labor market was red hot. That does mean hiring has eased and workers are finding it a little harder to find jobs. Yet, it’s running close to where it was in 2018-2019, indicating that this is still a strong labor market. Ultimately, here’s what’s important to keep in mind: Consumption makes up 70% of the US economy, and right now consumption is running strong, thanks to… Strong labor markets, which are pushing incomes higher to above the pace of inflation Higher net worth, which means households can spend more
May’s First Trading Day: S&P 500 and Russell 2000 Higher 69.2% of the Time The first trading day of May has had a bullish history over the past 26 years. DJIA, S&P 500 and NASDAQ have all averaged around 0.4% on the day. S&P 500 and Russell 2000 have the best track records, up 18 times or 69.2% of the time since 1998. With an average gain of 0.21%, Russell 2000 is slightly weaker. May’s first trading day’s worst loss was in 2020. DJIA and S&P 500 shed over 2.5% while NASDAQ and Russell 2000 dropped over 3%.
Buy In May and Stay? At Least in an Election Year “Spring is nature’s way of saying, ‘Let’s party!'” – Robin Williams Buckle up, as the trigger points for one of the most well-known investment axioms, “Sell in May and go away,” is nearly here. This gets a ton of play in the media, as the six months starting in May are indeed the worst six consecutive months on the calendar historically. The S&P 500 has averaged only 1.7% over those six months and moved higher less than 65% of the time. Now let’s be clear. Up 1.7% might not sound like much, but it is still an increase. Also, we do not advocate blindly selling due to the calendar. But it is worth being aware of this calendar effect, as you will hear a lot about it this week. Now here’s something that might be less well known. These “worst six months” have gained in eight of the last 10 years. Not to mention the month of May has been higher nine of the past 10 years, so maybe we should call it, “Sell in June and go away”? Election years also tend to see a summer rally and strength during these six months, with the May through October period up 2.3% and higher an impressive 77.8% of the time. Here’s another way of showing that a summer rally in an election year quite normal. What stands out to me is October tends to be quite weak, as those jitters are strong ahead of the election. Given this year started off with more than a 10% rally in the first quarter, what has tended to happen in election years that saw big gains early in the year? April and May were weak, but stocks usually bottomed in early June before a summer rally. So far, this year is playing out to form. How the market was doing going into these six months also mattered. Some of the worst “sell in May” periods have taken place when stocks were down year to date before May began, whereas if stocks were positive, the following months improved. In fact, when the S&P 500 was up more than 4% for the year at the end of April (as it likely will be this year), the following six months gained 4.2% on average and were higher nearly 78% of the time. Of course, when stocks were lower in April (like 2024) then those six months were quite weak, but much of this was due to the big drop in 1987. We aren’t overly worried about the normally bullish April struggling this year, as we were up five months in a row heading into it and some type of break was warranted. In fact, we wouldn’t be surprised if stocks consolidated for another month or so, working off some of the historic rebound off the late-October lows. We do not expect major weakness, but a break makes sense. However, since this is an election year and stocks have been strong so far this year, we think a summer rally and strength during these six months is likely. Lastly, a five-month S&P 500 win streak is about to end, proving once again that all good things come to an end. The good news is looking at the end of previous five-month win streaks showed that a month later things were dicey, but going out 3-, 6-, and 12-months showed above-average returns. In fact, a year later stocks have been higher every time (six for six).
The April Employment Report Tells Us the Economy Is Strong, But Not Red Hot The April employment report was the first one in months that went well against market expectations. Three blockbuster payroll reports in Q1 had conditioned sentiment towards expecting more of the same, but instead we got something less blockbuster(y). Payrolls grew 175,000 in April — below expectations of 240,000 and lower than the red hot Q1 monthly average of 269,000. This does shift the narrative from a “no-landing” scenario to “soft-landing,” i.e. a steady economy with inflation heading lower, which would allow the Federal Reserve to cut interest rates. Perhaps the best evidence here is aggregate income growth across all workers in the economy. Ultimately, income growth drives consumption, and aggregate income growth is the sum of employment growth, wage growth, and the change in hours worked. Over the last three months (through April), overall income growth grew at an annualized pace of 5.9%. That’s strong and above the pre-pandemic pace of 4.7%, but it’s far from “red-hot.” In short, there’s nothing in the employment data that suggests an overheating economy that will keep inflation persistently high and push the Federal Reserve to maintain policy rates as high as they are now (5.25-5.50%). If nothing else, this report makes the prospect of further rate increases even more unlikely, underlying what Fed Chair Jerome Powell said earlier this week. As discussed in my previous blog, Powell stated there’s not much risk of the dreaded “stagflation,” since unemployment is low and inflation has eased a lot. Make No Mistake, This Economy Is Good for Stocks Aggregate incomes running close to a 6% annual pace suggests nominal GDP is also running at 5-6%. That’s an environment that’s good for profit growth, which in turn is positive for stocks. Yes, payrolls did come in well below expectations, but 175,000 is above the 2019 monthly average of 166,000. You always want to be a little careful with monthly job numbers, because they can be revised, but over the last three months payroll growth has averaged 242,000. The corresponding number exactly a year ago was 237,000. In other words, the labor market has remained strong, with not much acceleration or deceleration. The unemployment rate did tick up from 3.8% to 3.9%, but April is the 27th month in a row in which the unemployment rate has clocked in below 4%. That’s the longest streak since the 1960s. I’ve mentioned in previous blogs how I prefer looking at the “prime-age” (25-54 years) employment-population ratio, since it gets around definitional issues that crop up with the unemployment rate (someone is counted as being “unemployed” only if they’re “actively looking for a job”) or demographics (an aging population with more people retiring and leaving the labor force every day). The prime-age employment population ratio rose in April to 80.8% — that’s only slightly below the high from last summer, and above anything we saw between 2001 and 2019 (when it peaked at 80.4%). In fact, the prime-age employment population ratio for women just hit an all-time record high of 75.5%. This by itself should tell you the labor market is strong, with more people participating in it. A Strong Labor Market Is Good for Productivity Growth A theme of our 2024 Outlook was that we may be seeing a resurgence in productivity growth. Over the last year, productivity grew 2.9%. That is well above the 1.1% annualized pace between the first quarter of 2020 and the first quarter of 2023, or the 1.5% annual pace between 2005 and 2019. A key piece of this is a strong labor market, which incentivizes businesses to invest more, and that’s what you need for productivity growth. Importantly, with productivity growth, workers can see strong wage growth without necessarily pushing up inflation. Falling inflationary pressures can allow the Fed to ease interest rates. Even if rates are shifted lower by a relatively small degree, that can further boost investment and keep the productivity growth engine running. This is something we saw in the mid-to-late 1990s. A similar situation bodes well for the economy and stocks.
Six Reasons This Bull Market Is Alive and Well “Sometimes the questions are complicated and the answers are simple.” -Dr. Seuss 2024 came out swinging, with the S&P 500 up more than 10% in the first quarter on the heels of adding more than 11% in the fourth quarter of ’23. Back-to-back double-digit quarters are quite rare, but the good news is they tend to happen in bull markets, something we’ve been saying we are in for a long time. April is usually a bullish month, but it saw the S&P 500 fall 4.2%, which included a well-deserved 5.5% mild correction mid-month. The economy remains on firm footing, but there are potential cracks forming. What could be next for stocks? We’ve been overweight equities since December ’22 and remain there today, as we expect to see stocks move to new highs this summer and the bull market to continue. Here are six reasons we think the bull market is alive and well. Big Starts to a Year Are Bullish Listen, after a five-month win streak we were probably due for at least a pause. We also saw some of the same bears who mocked us last year for being bullish turn into bulls themselves. With that kind of setup, it makes sense that some type of volatility was necessary to shake the tree. Even though the S&P 500 pulled back just over 5%, many of the former highfliers saw much larger corrections. As for the big start, we looked at other years that gained double digits in the first quarter and stocks were higher the rest of the year (so the final nine months) 10 out of 11 years. Yes, 1987 was the one year it was negative, but stocks were up 40% for the year in August back then, so we don’t see that repeating. The average return is skewed due to 1987, but the median return the rest of the year is a solid 8.2%, better than the median return for all years. Bottom line, a big start to a year shouldn’t be a reason to become bearish. In fact, historically it signals likely additional strength. This Bull Market Is Still Young The current bull market started in October ’22, which means it is now just under 19 months old. Would you believe that if the bull ended here and now this would make it the shortest bull market ever? That’s right, most bull markets last much longer, with the past 12 bull markets averaging more than five years in total. Taking this a step further, many bull markets started in the “bear market killer” month of October (this one included), and we found that those bull markets lasted even longer. The current bull market is up more than 40%, which might feel like a lot, but looking at the four bull markets since 1990 shows they all at least doubled. The bottom line is history tells us to be open to a much longer bull market and potentially large gains along the way. Stocks Like a President Up for Re-election We noted in our Outlook 2024 that the past 10 times a President was up for re-election stocks finished the year higher. It was election years with a lame duck President where things didn’t go as well. Taking this a step further, a surprise summer rally is normal when the President is up for re-election. This chart does a nice job of showing how strength the rest of this year is likely with a president up for re-election, while trouble brews when the President is a lame duck. It’s All About Earnings What drives long-term stock gains? It is earnings and the backdrop continues to look quite strong. The still healthy consumer, strong labor market, potentially lower rates helping housing, and improving manufacturing all suggest an economy that could surprise to the upside the rest of ‘24. Nominal GDP came in near 6% last year for one of the best years in recent memory, but the stage is set for similar growth this year. Remember, nominal GDP growth leads to profit growth and profits matter. S&P 500 first quarter earnings are up more than 5.0% currently, from 3.2% expected at the start of the quarter, according to FactSet. This would be the best earnings growth in nearly two years, while revenue is higher for the 14th quarter in a row as well. Corporate profits for the S&P 500 are expected to hit an all-time high this year, with a gain in ’24 of close to 11%. We’ve found that periods that have strong productivity (like we are seeing now) tend to come in even better than expected and we think 11% could be a tad low as a result. The mid-to-late ‘90s saw strong productivity, and also saw earnings and GDP consistently come in much better than was expected. It was the last decade, when productivity was low, that GDP disappointed consistently in the 2% range. Look at the quote at the top one more time, the easiest answer is earnings are strong and that is likely why stocks have been strong! The other thing we’ve seen lately is analysts coming in too low with earnings estimates, as they are still too skeptical of this recovery. Looking out a year, forward 12-month S&P 500 earnings have soared from $243 at the start of the year to $254 currently. When companies post record profits you tend to see stock prices follow suit and we don’t think this time will be any different. Profit margins and CAPEX Continue to Improve A cousin to earnings is profit margins and stronger profit margins could be another reason to expect a stronger economy and bull market. Yes, profit margins are improving due to cost-cutting, but this will likely create a leaner and more agile corporate America the second half of this year. We’ve been told for what feels like years now that profit margins have only one way to go and that is lower, but the opposite continues to happen. Improving profits and profit margins supported by continued economic growth next year would provide a strong tailwind for equities. Higher capital expenditures (CAPEX) is another positive. In fact, forward 12-month CAPEX is at an all-time high as well. Companies investing in themselves should lead to continued stronger productivity growth, which will help economic growth likely exceed expectations. Improvement on the Inflation Front Lastly, and maybe most importantly, we’ve seen overall improvement on the inflation front over the past year, but the past few months have shown that the path lower won’t come without some bumps. We remain in the camp that inflation will continue to improve and the blip we’ve seen early this year is more seasonal quirks and outliers that are unlikely to persist (higher auto insurance and higher financial services fees for example). We know that rents are falling in the private data, which gives a good estimate of prices for new or renewed leases. The rental price for a lease today is likely less than a similar lease over the last couple of years, but that has yet to flow to the government’s data, which includes all rents and shelter, even rent “attributed” to homeowners. Remember, shelter makes up more than 40% of the core Consumer Price Index (CPI), so any improvement here will quickly influence CPI data. But while we’re waiting for overall rents to catch up with changes in asking prices seen in private data like Apartment List and Zillow, keep in mind that if you remove shelter from CPI, inflation is actually running quite close to that 2% level the Fed targets. There has also been concern over higher wages impacting inflation, but we expect improvements there as well over the coming months and quarters. The recent JOLTS data showed a healthy but normalizing labor market as wage growth slows. The Indeed Wage Tracker similarly showed slowing wage growth. Remember the 1970s saw wage growth up around 9%, which did flow through to overall inflation. Wages are still solid right now, but more in the range of what we saw pre-pandemic. All of this matters, as it sets the stage for the Fed to cut rates this year, likely two times. We started the year with markets looking for 6-7 cuts, but it then fell to only one cut (with some vocally calling for a hike recently). Just as the pendulum had swung too far toward many cuts to start the year, we feel it has swung too far the other way now. With improving inflation data expected, the Fed should have the ammo to cut rates, likely starting in September, or at the very least to push back on the hawkish rhetoric. Either could be a nice tailwind for equities.
Typical May Up Early, Weak Middle, Strong Finish Over the last 21 years, the first three days of May have historically traded higher, and the S&P 500 has been up 18 of the last 26 first trading days of May. Bouts of weakness often appear around or on the fourth, sixth/seventh, and twelfth trading days of the month while the last four or five trading days have generally enjoyed respectable gains on average, but the last day of May has weakened noticeably with only NASDAQ gaining ground. Monday before May monthly option expiration is much stronger than monthly expiration day itself albeit weaker for small caps. S&P 500 has registered only ten losses in the last thirty-four years on Monday. Monthly expiration day is a loser nearly across the board except for Russell 2000 with a slight average gain (+0.01%). The full week had a bullish bias that is fading in recent years with DJIA down seven of the last eight and S&P 500 down six of the last seven. The week after options expiration week now tends to favor tech and small caps. NASDAQ has advanced in 24 of the last 34 weeks while Russell 2000 has risen in 26 of the last 34 with an average weekly gain of 0.88%.
Stocks Make Mom Happy Before & After Mother’s Day Remember to take time out this Sunday for all the Mother’s in your world. Over the last 29 years on the Friday before Mother’s Day Dow has gained ground 19 times. On Monday after, DJIA has advanced 18 times. Average gain on Friday has been 0.25% and 0.23% on Monday. However, Monday following Mother’s Day has been down 8 of the last 12 years. In 2019, DJIA suffered its worst post Mother’s Day loss going back to 1995, off 2.38%.
