Which way is out?

Stocks gained in Wednesday’s abbreviated session on weaker-than-expected economic numbers. Traders are eyeing politics carefully, skeptically, wondering when bets may be placed on November’s results.

And just like that. Everything seems to be going well… until it doesn’t. The economy is growing… um grew… last quarter. There is a plus sign in front of the number for Q1 GDP, which means expansion. Roughly translated into… er, good. The number, +1.4%, is not hot, but also not too bad either. I would stop short of saying “just right,” however. Personal Consumption, the largest component of GDP (around 67%) was somewhat anemic, falling to +0.98% from +2.2% in the prior quarter. That figure roughly tracks the goods and services you and I buy. In the first quarter, did you consume less than you did in the prior quarter? Come on, you know you did. Actually, on things, stuff, or whatever (not a technical category) you did spend less, exactly -0.51%. On services, which includes rent, insurance, and nail salons, you spent +1.49% more. Fixed Investment, which makes up around 18% of GDP, grew by an abnormally large +1.19%, helping the overall number look more attractive. The Fed should be happy with slower consumption as that is what the Central Bank is after with its restrictive interest rate policy. The hope there is if we demand less goods and services, it will allow price inflation to moderate. Ok, so it is definitely working on goods consumption. On fixed investment, which is largely controlled by companies investing in capital projects like machinery, plant, buildings, software, etc. Businesses must be bullish based on the jump in investment in Q1.

Will that bullishness continue and keep inflation higher? More importantly, will businesses continue to demand workers, keeping wages growing and consumers flush with cash to drive prices higher? The Fed would like to know the answer to that very question. The Fed would also like to know if businesses will cut back and possibly cause GDP to decline, which is the precursor to recession. As we have been discussing Q1 GDP, which ended in March, and we just celebrated Independence Day yesterday, it might be more prudent to address what is happening now, and what that GDP figure is for Q2, which ended last weekend. Well, we are in luck… or rather we WILL be in luck when the Bureau of Economic Analysis releases its first estimate of Q2 GDP in 2 weeks. Blue-chip economists are expected GDP growth to increase to +2.0% in Q2. They are expecting Consumption to rebound from its anemic Q1 showing and Investment to pull back from its hot Q1 growth. Beyond that, the economists are expecting a slowdown in the final 2 quarters of the year.

To recap. In the first quarter of the year, the economy was sluggish. We still don’t know exactly what happened in the last quarter which just ended. Economists are expecting it to have rebounded a bit. The Fed is clearly worried about that rebound because it may confound its plans to put everything on ice by just enough to extinguish inflation without completely killing all growth and causing a recession. Economists are expecting a mild slowdown in the quarter that we technically are in now (for about a week) and another slow quarter leading into the end of the year. Inflation numbers are moderating but for a few sticky sub-categories, and might I remind you that interest rates are still restrictive. We are talking a lot about rates cuts, but rates have not been cut yet 😉.

Supporting the “slowdown” this quarter and next is a growing collection of more current indicators of economic health. Looking at Purchasing Managers Indexes, we can see a struggling manufacturing sector. On Wednesday we saw ISM Services Index pull into contraction territory unexpectedly. Many economists have been expecting the labor market to fall off. Though that still has not happened, there are some early warning signs with weekly employment figures weakening slowly. This morning, we will get employment figures from June which are expected to show a decline in new Nonfarm hires with the Unemployment Rate remaining at +4.0%. Not low, but not high either. What this all comes down to is that this is still a tough race to call. Next week we will look for confirmation that the Fed’s good work is… well, working when we get CPI and PPI, aka inflation. The headline CPI number is expected to show a further slowdown in inflation, which should give the Fed a bit of comfort, given that all the numbers I mentioned above can easily surprise on the downside, and that is just a nice way of saying that the economy can throw us a nasty curveball. We don’t want that. Stay focused, stay cool.

WEDNESDAY’S MARKETS

NEXT UP

• Change in Nonfarm Payrolls (June) is expected to show that 190k new jobs were added, slightly lower than May’s 272k new hires.
• Unemployment Rate (June) was probably unchanged at 4.0%.
• Next week: earnings season starts on Friday, but before then we will get Consumer Price Index / CPI, Producer Price Index / PPI, University of Michigan Sentiment, and Chairman Powell will give 2 days of testimony on The Hill. That should be enough to keep the market moving up, down, to and fro, so check in on Monday to download the economic and earnings calendars.