Written by Steve Andrews
Economic Resilience
Against all expectations, the US economy avoided a recession last year and, thus far, has avoided the flat to negative growth expected in the first half of 2024. While growth will likely slow somewhat in 2024, compared with the second half of 2023, the next recession remains somewhere in the distant future. This is despite interest rates holding near 15-year highs.
Inflation Pressures
Historically, the Fed has moved aggressively to lower interest rates when the economy is in peril. However, economic data suggests the economy is performing well, and the Fed remains concerned about another inflation flare-up. They left the Fed Funds rate unchanged this month and are expected to hold firm again at the May 1 meeting. But the odds of a June rate cut edged up after Fed Chair Jerome Powell made his semi-annual report on the state of the US economy to Congress.
After many months of steady progress, the disinflation trend has run into a traffic jam. The Fed’s preferred inflation metric, the Personal Consumption Expenditures Index (PCE) was up 2.4% in January from a year ago, while February Consumer Price Index (CPI) was up 3.2%. Housing costs make up almost 34% of CPI and they continue to rise at a 5% pace whether you look at them over a 3-, 6-, or 12-month period. CPI (excluding housing) was up just 1.8% from February 2023.
Services Sector Trends
Fortunately, consumers have been spending despite the headwinds from higher prices, and continue to drive economic growth. This is bolstered by rising wages (up 4.3% over the past year) in a strong job market that has created over 3 million jobs over the past 12 months. In addition, US Household Net Worth hit a new record high in Q4 - rising $4.8 trillion last quarter to a record $156 trillion. Q4's bounce back was due to assets - mainly US stocks - which recovered from the late summer swoon. There was little change in the net worth of real estate values last quarter, but household debt rose 2.4%. In Q4, consumer credit rose at a 3.3% annual rate, while mortgage debt rose at a 2.1% rate.
The US services sector, which kept the economy from falling into a recession last year, continues to expand, according to the February ISM Non-Manufacturing Index. While the overall index eased to 52.6 from 53.4 in January, due to faster delivery times and a dip in the employment index, 14 of the 18 industries surveyed reported growth last month. In addition, the two most forward-looking subsets, business activity and new orders, rose to a red-hot 57.2 and 56.1, respectively. The services sector has grown in 44 of the last 45 months with spending on services up 6.3% from February 2023.
Housing Marketing Updates
The US housing market continues to edge forward despite the ongoing supply shortage. Following December’s sharp 8% rise in new home sales, sales increased another 1.5% in January as home buyers, frustrated by the lack of existing home inventory, have shifted their focus to new homes. In response, homebuilders have shifted their focus from multifamily construction to single-family homes. Single-family housing starts were up 22% in January 2023 from a year before and the number of units under construction remains near record highs.
Stock Market Dynamics and Investor Sentiment
The economic data and the promise from Artificial Intelligence (AI) have helped the stock market to grind out new highs with the S&P 500 up over 44% since its recent bottom in October 2022. While some pundits dismiss the rise as being driven by the “big seven” tech stocks, a look at the S&P 500 on an equal value basis (meaning all 500 stocks weighed the same) still shows a gain of over 30%. Anytime that the markets sit near record highs, investors get nervous that a big correction is around the corner. Because of that, they like to point to some soft monthly economic releases to suggest that we have already turned that corner. Adding to the uncertainty are the constant (sometimes big) revisions to prior months’ economic data we have seen of late in the reports on employment, housing, retail sales, etc. Most of the monthly economic releases we see are based on a small sampling of data which is then sprinkled with “seasonal adjustments” by the agencies that produce them, based on historical trends. These seem to be getting revised in a big way more and more simply because the seasonal factors that adjust every monthly release are based on historical data that has been so jumbled by the shutdowns that it takes a while to smooth the numbers out. We always warn against relying too much on a single month’s sampling (something the Fed recently cautioned on as well) – preferring instead to look at data on 3- and 6-month trend lines.
The Long-Term Outlook
On that basis, the economic data shows that the US economy continues to outperform expectations - be it avoiding a recession last year or avoiding the flat to negative growth expected in the first half of 2024. Current estimates for Q1 GDP growth are running between 1.5% to 2.5% and US productivity is performing much better than its historical norms, which should boost business efficiency and business’ bottom lines and, thus, support stock prices.
As the bulls now far outnumber the bears, with the Bull / Bear ratio for stocks rising to levels not seen since 2017, investors and analysts remain on edge - not convinced that corporate earnings and profits will continue to grow as they have in the past. This skepticism mirrors the mood that prevailed from the end of the Great Recession in 2010 through 2016 when investors were constantly worried that the next recession was just six months away. Those concerns dampened growth and investment and kept the economy on a tepid 2.1% GDP growth path. While the rate of growth was underwhelming, the one benefit derived from it was that it kept the Fed on the sidelines as inflation floundered around 1.5%.
The Fed has once again moved to the sidelines and their shadow, which cast a pall over the markets for the better part of two years, has been erased. With or without the rate cuts, the economy continues to move forward, led by the consumer, whose spending is now being fed by organic income growth rather than the government largesse that supported spending in the aftermath of the pandemic. The situation is far from perfect but, so far, so good.
