Despite the Negative Speculation, the Economy Isn’t Tanking
The economy isn’t falling apart… it’s returning to normal.
Lately, it seems like it’s hard to open a finance-dedicated website or turn on a similarly dedicated news channel without seeing or reading something negative about the economy. For instance, the headlines last week were filled with dire predictions. Job growth data for August was weaker than expected, causing Bloomberg and CNBC to generate headlines about stagflation and a looming recession.
However, if those media outlets dug a little deeper, they’d notice a different trend. If they looked at the bigger picture spanning the periods before and after the COVID pandemic, they’d see that trends are returning to normal…
The above chart shows the average monthly nonfarm payroll gains for 2017 through 2024. I left out 2020 due to the erratic swings around the pandemic-driven shutdowns. But the one thing that stands out is the year-to-date average gain of 185,000. It’s very close to the 177,000 average increase from 2017 through 2019.
But it’s not just the jobs market where we’re seeing this shift. The same change is happening with economic growth. That means that as spending and consumption continue to slow, domestic output should return to a more predictable and stable pace.
That means the Federal Reserve can enact a series of interest rate cuts without stoking inflation once more. Now that could mean the outsized annual gains experienced in the stock market over the last few years could be behind us. But the change should act as a tailwind for a steady long-term rally in the S&P 500 Index.
But don’t take my word for it, let’s look at what the data’s telling us…
The best way for us to see what domestic economic activity looks like is to follow quarterly gross domestic product (“GDP”) data from the U.S. Bureau of Economic Analysis (“BEA”). It gathers data from various sources, including surveys, administrative records, and other government agencies. The figures cover different sectors of the economy, such as consumer spending, business investments, government expenditures, and net exports.
The BEA then estimates growth figures by combining a few methods. It measures the total value of goods and services produced. It calculates the total income earned by individuals and businesses. And it adds up the total spending on final goods and services.
The raw figures are then adjusted to account for things like seasonal variations, inflation, and other factors to ensure they accurately reflect economic activity. The numbers are revised several times during each quarter to ensure they accurately reflect economic growth.
According to numbers released in late August, the U.S. economy grew 3% in the second quarter of this year. That was up compared to the 1.4% growth experienced in the first quarter…
Now, the first thing you’ll notice in the chart above is that it looks a lot like an electrocardiogram image you may see at the doctor’s office or on your iPhone. The idea is similar because while the EKG chart shows us whether our hearts are functioning normally, the above GDP chart is doing the same.
The part that stands out to us and makes it look so much like the previously mentioned medical readout is the sudden drop and rapid rebound in 2020. The dip was driven by all the layoffs that happened during the onset of the pandemic. And the jump was the result of the recovery that ensued as households found work and began spending savings and stimulus checks.
But the parts we really want to look at are the ends… because they cover the periods before all the extra money was introduced to the economy and after those excess savings were flushed out. So, they’re a better comparison because we can get a sense of what real activity looks like.
Now, in 2019, the average quarterly rate of growth was right around 3.2%. That’s a pretty good number but seems light when we consider 2021 saw an average quarterly growth rate of just over 5.4%. But when we look at 2024, we see a year-t0 date average of 2.2%, much closer to the pre-pandemic number.
Yet, what’s even more interesting is when we dial the data out even further to look at the quarterly numbers since the start of 2009…
The first thing that jumps out to me in this chart is how steady it appears when we look beyond the pandemic effects. In fact, when we tally all the numbers and then divide them by the total number of quarters involved, we get and typical growth rate of 2.3% from the start of 2009 through mid-2024. In other words, the 2.2% output average so far this year is telling us the economy is acting normally.
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But let’s look at one more number to see where growth is headed. We can do this by observing the Atlanta Fed’s quarterly GDP forecast…
The regional bank’s economic team produces these forecasts by following the daily economic figures. It then tallies the numbers using a similar formula as the BEA to try and predict what quarterly output looks like. Based on the September 9 forecast, we’re on track for 2.5% growth this quarter. That’s right in line with the long-term average.
Look, ever since the Fed started hiking rates, Chairman Jerome Powell has said he wants to see growth return to, or even go below trend before cutting interest rates. That way policymakers will know that they’re not stoking a rebound in inflation growth. In that event, they’d have to start raising once more.
Well, based on the data we just looked at, growth has stabilized once more around the long-term trend. The implication being that if the Fed waits too long before easing policy, it could start to crush the economy.
So, don’t be surprised when the central bank starts cutting rates later this month, spurring a series of similar actions down the road. The shift will underpin steady economic growth and a steady long-term rally in the S&P 500.
Five Stories Moving the Market:
Bank of Japan board member Junko Nakagawa repeated the bank’s stance of pursuing more rate increases, sending the yen to its strongest level in eight months; Nakagawa echoed the view previously offered by Governor Kazuo Ueda and other officials – WSJ. (Why you should care – similar commentary in the recent past has caused the yen to rally and stocks to drop)
The Federal Reserve will lower interest rates by 25 basis points at each of the U.S. central bank's three remaining policy meetings in 2024, according to a majority of economists in a Reuters poll – Reuters. (Why you should care – according to the CME’s Fed watch tool, bond traders are pricing in 100 basis points worth of cuts)
August U.S. consumer price index data is expected to show muted increases, possibly playing into a Federal Reserve debate over how much to cut interest rates – Bloomberg. (Why you should care – a weak enough outcome could boost speculation for a 50-basis point rate cut)
JPMorgan president Daniel Pinto warned Wall Street’s net interest income expectations for nest year are too high, as current expectations for interest rate cuts are likely to squeeze profits from loans – FT. (Why you should care – any significant pullback on dwindling loan margins is likely to provide an attractive entry point in large cap financials)
Wall Street is anticipating a hit to corporate earnings and the stock market if Democratic presidential candidate Kamala Harris wins in November and enacts promised tax increases; Goldman Sachs analysts said that at Harris' 28% rate, earnings of S&P 500 companies would take a 5% hit while Trump's proposed cut would boost them about 4% - Reuters. (Why you should care – the lack of a clear advantage for either candidate headed into the election is likely to leave the stock market in limbo)
Economic Calendar:
BOJ’s Nakagawa (Board Member) Speaks
China – New Yuan Loans for August
Japan – Machine Tool Orders for August
U.K. – GDP for July (2 a.m.)
MBA Mortgage Applications?(7 a.m.)
CPI for August (8:30 a.m.)
Energy Information Administration Crude Oil Inventory Data (10:30 a.m.)
Treasury Auctions $39 Billion in 10-Year Notes (1 p.m.)