Despite softer consumption and job trends, some stocks may be built to weather it.
KEY TAKEAWAYS
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Consumption slowed in Q1, dragging down GDP despite surface-level economic strength
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Net exports were the biggest drag due to tariff-related import surges
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AI infrastructure investment (up 73%) provided key economic support
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Continuing jobless claims signal weakening labor conditions
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The Fed remains sidelined, awaiting unclear data before acting on rates
MY HOT TAKES
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“Constructive” doesn't mean blind—it means selective
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Tariffs created chaos, but also opportunity for the prepared
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GDP is more than a headline number—look at the components
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The Fed’s paralysis is becoming part of the problem
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AI spending isn’t just a tech story—it’s a macro tailwind
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You can quote me: “The Fed has rendered itself helpless, backing itself into a similar corner to the one it was in in 2021–waiting for something.”
Look both ways before crossing. In case you haven’t seen some of my recent interviews, I will just tell you that I have been constructive on equities since the S&P 500 bottomed out in April. Constructive is a fancy industry word for “I am buying,” “I am bullish,” or “I like the market here.” My reasons back then, as I was fielding daily calls from clients wondering if they should sell everything and bury canned food caches in their backyards, were as follows. As 2044 drew to a close, certain sectors, there were stocks with lots of justified positive momentum. They sported fantastic fundamentals and were tapped into target markets that were unquestionably large and growing… fast. They had great management, and the markets were behind the move, as evidenced by the strong, positive momentum. Now, of course, there is a heck of a lot more analysis that goes into making “buy” decisions, and not all stocks, even in the same industry group, are the same.
As we all know, things changed rapidly for these high-flyers once the President was inaugurated. To be exact, just a few days after he was inaugurated. In fact, the first couple was still probably unpacking boxes in the White House when the President announced his first tariff salvo on Canada, Mexico, and China. And it was shock and awe–fare larger and broader-reaching than many expected. It became clear that the President was intent on making good on all campaign promises… all.
The first sortie of tariffs was enough to leave traders jaw-gaped and could, themselves be economy killers. Three of the US’s largest trading partners were in the administration’s crosshairs. Even the peppiest of bulls began to worry and would likely have sold if not for the legendary “Trump Put,” from his first Presidency. As markets sold off, many were banking on the President caving eventually as he watched great 2024 gains melt away, his Trump Bump becoming a Trump Dump. But nobody knew the strike price of that option. In other words, when… not IF he would relent. Just when the market was about to run out of oxygen, he did it. No. He did not relent! He tripled down on Chinese tariffs pressing the slider to 145%. It seemed like a fever-dream playing out in the markets. As we all gasped for air when the S&P 500 closed below 5000, I felt that there was a possibility that the President was getting ready to turn the ship around. It was a low possibility given his recent behavior, but knowing that his ultimate goal was not just to kill US companies, foreign traders, and the consumer. No. He was looking for a deal… at some point.
Thankfully that “point” came shortly after and that low-probability event occurred when the President signalled that he was open to negotiations. He decided to delay the “Liberation Day” reciprocal taxes and negotiate. That is where it all began. It was not clear how the negotiations would play out and how long they would take, but the fact that the President was seeking deals was almost like a light at the end of the tunnel, albeit a small one. That "light" was the basis for my constructive stance. As the threat of all-out trade war with no end abated, the fundamentals that pre-existed, could take back the reigns. So was it just pedal to metal then? Well, no.
But, there was still the up-in-the air possibility of collateral damage. What might all that stop and go, stop and go do to the economy? Would consumers just stop buying out of fear? Would companies stop investing until tariff negotiations were finalized? Would hiring stop? Worse yet, would layoffs pick up in preparation for tariffs and lower margins? Soft numbers like consumer sentiment were all over the place with sharp declines and sharp recoveries which seemed quite correlated with the state of the administration’s tariff negotiations. Similarly, purchasing managers indexes, or PMIs, were all over the place, swinging back and forth with every gain and loss in trade negotiations. Rightly so, because tariffs are serious business. They are a tax which is borne by either foreign supplier, the importing company, or the consumer… or all three. The first would be best, but least likely. Ultimately it is likely to be all three, but most burdensome to US importers and consumers. If consumers bear the cost there would be inflationary implications, and if the companies covered the cost, there would be profitability implications–both, painful in different theaters.
Ultimately, these could be a drag on GDP if consumers spend less and companies stop investing. The situation would worsen if companies began to lay off workers. Even the most zealous consumers cut back on spending when they are unemployed.
Thankfully, we have the Fed, whose only job is to manage inflation and keep the labor market stable. Unfortunately, the Fed has rendered itself helpless, backing itself into a similar corner to the one it was in in 2021. It is waiting for data to act. What that data is and what it actually looks like appears to be unknown. Rate cuts? None for now. Maybe later this year starting in September, but with an outside chance of one at the FOMC’s next meeting in July (20% chance).
We are now just about done with Q2, but Q1’s economic numbers flashed us some interesting signals. Generally speaking, the economy was solid on the surface. However, GDP declined. That’s right, it contracted. When the first of several estimates was released, it was clear that the basis for the decline was a huge decline in Net Exports. Companies rushed to surge imports ahead of tariffs, while exports declined. This caused a big enough drag on GDP to pull the whole number down. It’s just math, silly. C + I + G + (exports - imports). Yeah, it was that last expression.
Ok, so what about the other three aggregates. G, government spending? Well we know that it is still in the DOGE-cycle and likely to be under some growth pressure. That leaves consumers and capital investment. Those two alone make up most of the GDP with consumers being the largest contributor (~70%). That is why I am obsessed with it! 😉Further, it is reasonable to assume that companies would cut back on spending in an uncertain trade environment. Yesterday, we got the Bureau of Economic Analysis’ final revision of Q1 GDP, so we can see what ACTUALLY OCCURRED in the economy as companies, consumers, AND INVESTORS geared up for the promised “Liberation Day,” which technically took place in the first days of Q2. But what might have companies and consumers done leading up to the end of the quarter that may be telling?
If we avoid discussing Net Exports, we see a noticeable slowdown in consumption. It still grew by 0.31%, but that is significantly lower than the 4 quarters that preceded it (1.3%, 1.9%, 2.48%, and 2.7%, respectively from Q1 of ‘24). Check out my favorite ECAN <GO> chart from Bloomberg to get a good picture of GDP and its components since Q1 of 2023. Bear with me.
On this chart you can see clearly how Net Exports, the orange bar, dragged GDP down. You can also see, if you squint how Government Consumption also declined (teal bar). The blue bar, Consumption, which is around 68% of GDP was too small to help the overall figure. But there was another anomaly. The pink bar, which is Change in Private inventory. Though this was positive for GDP, it represents the surge in inventory imports ahead of tariffs, which is offset by the Net Exports. The final notable item on this chart is the larger-than-normal yellow bar which represents Fixed Investment. That includes intellectual property products, nonresidential buildings, and nonresidential equipment. Equipment grew by an eye-popping 8%! Within that category is transportation and industrial equipment, but those grew nominally, but the third sub-category, information processing equipment grew by almost 73%! That group includes–you guessed it–AI infrastructure build-outs. Now, it wasn’t enough to keep the whole economy in the green, but it certainly had a big hand in minimizing the -0.5% GDP decline. Hold that thought for 2 more minutes.
Up until now, we have only been covering what happened in Q1, which ended in March! We are now in June and Q2 is about to end. We won’t have a look at Q2 consumption until July 30th and still that represents the quarter that we are currently in. At the end of July, we will be in Q3! Well, if you remember something I said earlier about employment and consumption being closely linked to consumption, you might want to have a look at the weekly labor numbers. Most folks look at Initial Jobless Claims to assess how many folks may have lost OR GAINED jobs in a week. Losses are obviously bad and they have been averaging around 243k losses per week. This seems like a lot and it has slowly grown in the past year or so, but it still is not quite in the panic zone. But there is a problem with that number. It only tracks initial jobless claims. It is not offset with newly hired workers. In a strong labor market, laid-off workers are able to pivot quickly. So are companies hiring?
Let’s have a look at another, less-followed series: Continuing Jobless Claims. That is, as its name implies, folks who remain unemployed and file for unemployment benefits. The latest reading is 1.974 million. That seems like a lot, and it is, but to really appreciate what it means, you have to observe the chart. Check it out and follow me to the finish… finally. 🤸
I won’t dig into it, but that is not a healthy trend, growing long-term unemployment. The Fed should note this trend and be somewhat concerned.
So, to wrap it all up, not everything is rosy in the economy. Q1 looked fine, but there were some clear trends. Consumption was weaker but AI spending offset some of the pain. We still don’t know what Q2 will look like, but those trends are likely to have continued, but without the inventory and import surges. Recent, current labor market data suggests a weakening labor market which will have a direct impact on consumption, the biggest component of GDP. “So, why are you constructive despite all this, Mark,” you wonder. It is not “why” but “where,” that is important. Remember all that equipment being invested in? Remember why that is growing? Well, that is likely to continue. Not all stocks sectors are the same, and not all stocks within those sectors are the same.
At this point, I will step back and let you do the rest. Be diligent, remain vigilant. These tariff wars will eventually resolve themselves and the President is close to closing a number of key negotiations. Resolution will be positive for markets, but let’s hope that structural collateral damage to the economy stays at minimum. Let’s talk again at the end of July, when we get our first estimate of Q2 GDP.
YESTERDAY’S MARKETS
Stocks rallied yesterday despite some troubling economic news. Administration officials are reportedly softening their stance on the July 9th reciprocal tariff deadline and stocks liked that. Overnight, WHILE YOU SLEPT, Howard Lutnick announced that a trade deal with China is close, and that will certainly drive trade today.