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).
