The media screamed “recession,” but the data whispers “wait for Q2.”
KEY TAKEAWAYS
MY HOT TAKES
Once upon a time. I know this is hard, but can you remember–back in the day–when you heard on the evening news that Gross Domestic Product shrunk, you got a little bit… er, nervous. The next morning you opened your front door, unfolded your newspaper sitting neatly on your stoop, and there it was, the headline of the day “US Economy Shrinks for First Time Since 2022.” Your first thought was probably, “did the economy even shrink in 2022,” and then you remembered how poorly your portfolio performed that year, and you remarked to yourself, “I guess it must’ve.” But then your brain shifted back to reality. It was confirmed by the press; the Economy had slipped. Suddenly, you were gripped by fear, wondering if you should cancel the summer vacation, perhaps switch to choice beef from prime, spiff up the resume, consider carpooling, or maybe even… …drink tap water. 😱 You were overcome with sheer panic.
What if I offered you the same headline today? How would you respond? Would you blame Biden, and thank the Lord that President Trump will save us? Would you blame President Trump and thank the Lord that the Fed and Jerome Powell will save us? How about all the above, and just k e e p o n s p e n d i n g. That may just be the way things are these days. Before you decide, let’s look at the numbers.
As reported yesterday, GDP did indeed decline by -0.3% in Q1, a bigger than expected drop. If you weren’t paying attention in the weeks leading up to yesterday’s release, you might have missed the fact that economists were expecting a decline. But, yes, they were expecting a -0.2% decline. So, it was not just a decline, but it was a bigger than expected decline. Have you heard enough? Of course not. Pay attention.
Can you guess what contributor to GDP I was eager to see? My regular followers know that I was keen on learning about Personal Consumption Expenditures–CONSUMPTION. You know, because you are an ardent reader 😉, that consumption makes up around ⅔ of GDP. That means consumer health is paramount in keeping the economy on the rails.
We know that in the first quarter, many consumers rushed out to buy big-ticket items before the wave of tariffs hit with the potential to push prices higher. In other words, they front-loaded annual purchases. This had me believing that goods consumption would be higher in Q1 than it was in Q4 of last year. Seems like a reasonable hypothesis, right? Well, guess what, it didn’t. Goods consumption grew by just 0.11% after increasing by 1.3% in the prior quarter. Ok, not great, but goods consumption only represents one piece of consumption, like only ⅓ of consumption. Within goods, durable goods, which are the items we expected to have been strong due to that purchase front loading, actually declined by -0.26%. Services consumption–we love services–makes up the remaining 66%, and that grew by a more respectable 1.1%, but it was lower than Q4’s 1.41% gain. I would give that overall quarter over quarter slowdown in consumption growth a grade of ‘D’.
But, to be fair, it’s not all about you… … and me, consumers. No. Business investment is another input in economic growth. The thesis there is that companies started paring back on capital investments due to all the tariff policy unknowns. But guess what? Fixed Investment (as the pros call it) grew by 1.34% after declining by -0.2% in the prior quarter. That is a positive development.
Only one more big spender left, and that is the Government. Do I have to give you the thesis on the Government’s spending growth path in Q1? Of course not, Elon Musk has been slashing and burning his way through government budgets, so, clearly, we would expect government consumption to decline. And it did, pulling back by -0.25% after increasing by 0.52% in the prior quarter.
Where does that leave us? Well, so far, consumers flagged, businesses held up, and the Government is pinching pennies. That alone would be a less than positive build up to GDP, but it gets even more complicated.
Remember, that GDP also includes net exports. Why? Because when we import goods and services, we are moving dollars OUT of the domestic economy. On the converse, when we export goods and services, we bring foreign dollars INTO the economy. You know that the US runs a pretty consistent trade deficit, so naturally, we would expect net exports to be negative. To be clear, it is not always negative, but mostly negative.
Remember our thesis up top? The front-loading one. Well, we expected business would front-load imports to beat tariffs. And they did… big time. Net exports declined by -4.38% after increasing by a slight 0.26% in Q4. That was it, any hopes of even a slight increase in GDP would be overtaken by a decline of that magnitude. So, our thesis of front-loading held up here. Further, a not so commonly discussed aggregate within GDP is change in private inventories. GDP really represents total production and not just sales, technically speaking. Therefore, if a company builds up inventory but doesn’t sell it, it is still counted in economic output. So, if we go back to our front-loading thesis, we would expect inventories to have grown in Q1, and, in fact they did by 2.25% after retreating by -0.84% in Q4. While the inventory increase minimally impacts headline GDP (0.05% weighting), it supports our thesis on front-loading.
In summation, consumers were a no-show, business carried on, the government was slashing spending. Companies sped up imports and are building up inventories. If they hadn’t the GDP decline may not have appeared too stark, if at all. So, was this really just an over-sensationalized, headline-grabbing print?
To answer that we have to take a step back and remember that the bulk of tariffs are not included in Q1 results. Remember many were delayed and some were later modified, some down and some ratcheted higher. Therefore, the real effects of the tariffs will more likely show up in this quarter’s GDP. Moreover, and perhaps more alarming is all those front-loaded purchases by consumers and imports by companies will NOT occur in this quarter, however, at least net exports are likely to drop. Another takeaway is that while we know that tariffs will certainly have direct effects on business and ultimately consumers, they will also have indirect effects on purchase patterns. The big and final question to ponder is whether or not hearing that the economy contracted last quarter will cause you to switch from fancy bottled water to tap water. Stay tuned, this saga is far from over.
YESTERDAY’S MARKETS
Stocks managed to eke out a mixed close yesterday after falling deeply in the red on early-session, negative economic data. Traders scoured the numbers searching for not-so-negative implications, and rumors that Chinese negotiators have been contacted by the US set stocks ablaze causing a late-session rally.
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