Weak U.S. GDP Brings Back Talk of Dreaded Stagflation

Apr 29, 2024

By Ben Norris, CFA, Senior Investment Strategist, Vice President
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Stock markets got back on track last week with the Dow Jones Industrial Average (DJIA) gaining 0.7%, the S&P 500 (SPX) climbing 2.7% and the Nasdaq Composite (COMP) rocketing 4.2% higher. SPX and COMP ended three- and four-week losing streaks, respectively, while each saw their best weekly performance since November. It wasn’t economic data and renewed hope for interest-rate cuts that pushed stocks higher; rather, it was strong earnings results from a handful of mega-cap companies. That should sound familiar, because we’ve written something similar dozens of times over the past two years—each time it appears that the stock market is beginning to see broader gains, companies like Microsoft (MSFT) and Alphabet (GOOGL) find a way to once again dominate gains. Small-cap stocks did perform well last week as the Russell 2000 (RUT) climbed 2.8%, thanks to strong sector performance in technology, consumer discretionary and industrials. However, year-to-date performance of RUT remains disappointing at -0.8%; it is one of just two major U.S. indices in negative territory over that time.

First-quarter earnings have been a bit better than expected so far—nearly 50% of SPX companies have reported, and earnings growth is expected to come in around 3% higher than a year ago (earnings growth is projected to be back-loaded in 2024). Roughly two-thirds of companies that have reported beat consensus earnings expectations with an average surprise of 9%, but just one-third of companies have reported stronger-than-expected revenues, which is well below historical averages. Full-year consensus estimates for SPX earnings and revenue growth point to 9% and 5%, respectively, but revenue estimates have started to decline lately, and I am skeptical that the index will be able to achieve what feel like lofty earnings estimates by relying on margin expansion alone.

Last week’s economic data failed to meet expectations, with first-quarter real gross domestic product (GDP) growth showing a very surprising 1.6% print versus the 2.5% economists expected. The 1.6% GDP reading is the slowest growth the U.S. economy has seen in nearly two years, and the level of weakness here further complicates things for the Federal Reserve (Fed). GDP growth continues to be propped up by strong consumer activity as personal consumption expenditures contributed 1.7% to total GDP growth in the first quarter, indicating that the remaining components added up to a -0.1% contribution.

Making matters worse, the GDP price index was up 3.1% during the quarter, still well above the 2.0% level the Fed targets. On the heels of the GDP report was a personal consumption expenditures (PCE) report that failed to show signs of progress on the fight against inflation. March PCE increased 2.7% year-over-year, higher than the consensus estimate of 2.6% and February’s 2.5% reading. Core PCE, which strips out food and energy prices, rose 2.8% from a year ago. What is particularly concerning is that the three-month annualized PCE inflation rate climbed to 4.4%, indicating that recent price trends are moving the wrong way. Fed policymakers have continued to reiterate they want confidence that inflation is sustainably moving toward 2.0% before moving forward with rate cuts—this report must have eroded some of that confidence.

While the Fed waits for restrictive monetary policy to work its way through the economy, extraordinary circumstances such as shipping disruptions in the Red Sea, geopolitical tensions and the collapse of the Francis Scott Key bridge in Baltimore may put further pressure on prices. Expectations for rate cuts have shifted dramatically since the beginning of year, and it looks less and less likely that the Fed will be able to follow through with cuts in 2024. The CME Group’s FedWatch Tool now indicates that just one 0.25% cut is the most likely scenario through the end of the year, down from 1.50% in total cuts just a few months ago.

Despite what appears to be slowing growth, the U.S. labor market has been more resilient than many anticipated given the level of policy tightening. Initial jobless claims have hovered around 200,000—a level that indicates strong labor trends. Similarly, continuing jobless claims (1.78 million last week) remain well below 2 million, the typical level associated with a healthy job market.

In other economic news, the services Purchasing Managers’ Index (PMI) weakened to 50.9, while the manufacturing PMI fell to 49.9. Levels below 50.0 indicate a contraction in activity. The services index has remained robust throughout this cycle, but it appears that it may be running out of steam here. The manufacturing PMI climbed above 50.0 in February after spending 16 months in contraction territory, only to falter just a month later. The cumulation of all the data we look at continues to present a complicated picture of the path forward. Despite the Fed’s best efforts, prices continue to rise (partially due to a strong labor market) despite what appears to be a cooling economy. It has been several quarters since the word stagflation (an economic environment where growth slows while the inflation rate remains elevated, and a headache for policymakers) has been thrown around, but the latest data suggests that it could become a real possibility if economic growth weakens further from here.

This week’s economic calendar is filled with impactful events and will be headlined by the Federal Open Market Committee’s policy decision and the commentary from Fed Chair Jerome Powell that will accompany it. Other datapoints of note will include a busy earnings calendar, a variety of employment data as well as an update on the Institute for Supply Management (ISM) Services Index.

None Scheduled
9:00 AM S&P Case-Shiller Home Price Index Feb. 6.6%
10:00 AM Consumer Confidence April 103.5 104.7
8:15 AM ADP Employment April 200,000 184,000
10:00 AM Construction Spending March 0.3% -0.3%
10:00 AM ISM Manufacturing April 50.2% 50.3%
10:00 AM Job Openings March 8.7M 8.8M
2:00 PM FOMC Policy Decision
2:30 PM Fed Chair Powell Press Conference
8:30 AM Initial Jobless Claims Apr. 27 210,000 207,000
8:30 AM U.S. Productivity Q1 1.0% 3.2%
8:30 AM U.S. Unit Labor Costs Q1 3.0% 0.4%
8:30 AM U.S. Employment Report April 250,000 303,000
8:30 AM U.S. Unemployment Report April 3.8% 3.8%
8:30 AM U.S. Hourly Wages (y/y) April 4.1%
10:00 AM ISM Services April 52.0% 51.4%


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