Wentz Weekly Insights
GDP Declined in Q1, That Does Not Mean Recession, Yet…
Despite the recent pullback in the markets, the economy is still growing, driven by continued strength in the consumer and business and residential investment. The headline figure on the recent GDP (gross domestic product) report released last week might have shown a different story. GDP fell at an annualized rate of 1.4% in the first quarter of 2022, well short of the expectation of a 1.0% increase.
GDP is the measure of the value of all the final goods and services produced over a time period in a country. GDP is the growth in consumer spending, business investment in things like equipment, structures and intellectual property, homebuilding and home repairs, government spending/investment, the change in inventories, and net exports (exports minus imports).
The 1.4% decline was due to factors most likely to be temporary. First, a surge in imports due to the strong consumer caused a wider trade deficit and a net negative to GDP by 3.2% as the U.S. imported much more than it exported. Inventories increased $159 billion in Q1, but at a slower pace than $192 billion in Q4, contributing a negative 0.8% to GDP. Finally, government spending declined compared to Q4, contributing a negative 0.5% to GDP.
More importantly consumer spending rose 2.7% in the quarter, contributing 1.8% to GDP. Investments remained strong as well, both from businesses and home building. Residential investment (mainly home building) rose 2.1%, contributing 0.1% to GDP, while business fixed investment rose 9.2% in the quarter contributing 1.2% to GDP. These components make up the bulk of GDP and are all inputs to private domestic final purchases (FDFP) which gives a much more accurate picture of underlying domestic demand. We prefer this measure when calculating economic growth, which indicates annualized growth of 3.7% in Q1, still above the recent trend.
While domestic growth is still relatively strong, it may slow in the months ahead as the economy slows, shortages and supply chain issues persist, inflation remains high, and the Fed reaches a more restrictive level of monetary policy. The Federal Open Market Committee (FOMC) holds its policy meeting this week with a policy announcement Wednesday afternoon where it is widely expected to raise rates 50 basis points and announce the start to quantitative tightening, or reduction in its balance sheet as previewed in the previous meeting’s minutes.
The market anticipates these changes but last week was more focused on earnings reports with nearly 40% of the S&P 500 reporting last week. It was perhaps the most important week of earnings with the big five tech giants reporting as well. Just these five companies make up 20% of the S&P 500 and can drive performance from day to day (Amazon’s 14% decline Friday subtracted 0.5% from the S&P 500).
Google had a mixed quarter with strength in its cloud segment but slowing ad growth, particularly in YouTube due to the reopening of the economy and people spending less time at home. Microsoft easily beat expectations thanks to solid performance within its cloud segment, particularly its Azure service. Meta (Facebook) beat on very low expectations as user engagement unexpectedly improved. Apple beat expectations, driven by strength in iPhone sales, but commentary suggested lower sales in Q2 due to supply constraints and impacts from Chinese lockdowns. Finally, Amazon reported mixed results with strength in its cloud service AWS, but slowing retail sales and advertising revenue, while forecasting revenues and operating income below estimates.
Elsewhere, commentary has been largely mixed. For example, Sherwin Williams said raw material costs and logistic constraints are easing, while Whirlpool said shortages will persist for the remainder of the year and 3M saying supply chain challenges will continue for the foreseeable future as improvements did not materialize in Q1 as it expected.
Regardless of the mixed commentary, the common theme was continued shortages, supply chain issues, and higher costs, which we think will continue. Because of these issues the market dropped 3.3% last week and fell 8.8% in April for its worst month since March 2020 and worst April since the Financial Crisis. This is the weakness we have been writing about in recent newsletters and the reason we turned more defensive near the beginning of the year. We look to continue adding defensive positions, particularly those that are value oriented and that paying a steady stream of income through dividends.
Week in Review:
It was another volatile day Monday with a sharp reversal in stocks again, this time to the upside as stocks opened lower but were able to gain some momentum on the upside to close higher and near the highs of the day. A selloff in stocks on Chinese exchanges, with the Shanghai and Heng Seng indexes down 5.1% and 3.7% for the day respectively, was noted on Monday as China deals with an acceleration in Covid cases. This created more concerns over lockdowns and supply chains issues as well as demand, particularly oil which was down 3.5% and resulted in energy being the worst sector on Monday. But the biggest news of the day was Twitter’s board accepting Elon Musk’s $44 billion all cash buyout offer ($54.20/share), making Twitter a private company once the deal closes. Indices were higher with growth and tech outperforming as the NASDAQ was up 1.29% while the S&P 500 gained 0.57%.
Equity markets started on a weak note again on Tuesday. Regarding the covid outbreak in China, authorities have started a massive testing campaign, adding to concerns over more lockdowns. In addition, the Russian Foreign Minister warned the west of a “considerable” chance of nuclear war if it continues to deliver weapons to Ukraine. On economic data, durable goods orders rose more than expected driven by autos, electronics and electrical equipment, home prices rose at the highest monthly rate ever at 1.9% and up 19.8% from a year ago, the third highest y/y rate ever, while new home sales fell 9% in March due to a lack of inventory. Markets drifted lower as the day progressed and finished at the lows of the day and near the lows of the year. Selling was broad with only 28 S&P 500 members finishing positive. The NASDAQ had its worst day since 2020, dropping 3.95% and is now down over 20% from its highs, while the S&P 500 fell 2.81%.
A wave of earnings released Tuesday afternoon set the tone for Wednesday trading which was largely mixed in another day of volatile trading. Positive results from several tech companies sent the sector higher, along with other cyclicals. Stocks opened lower but moved higher throughout the day and finished higher by 0.21%.
Thursday morning was met with the first estimate of first quarter growth that showed a 1.4% decline in economic activity, however the decline was due to lower inventory growth and a larger trade deficit, offset by strong consumer spending and business and residential investments. A decent showing in earnings reports by growth companies sent stocks much higher for the day with all sectors ending the day in the green and the NASDAQ closing higher by 3.06%.
Economic data Friday morning included personal income and consumer spending growth in March that were both higher than expected. However the highlight on Friday was Amazon’s 14% loss due to an earnings miss a lower than expected sales and income guidance. This dragged down the growth style and consumer discretionary sector, along with the NASDAQ to end the week and month of April on a lower note. In fact, April was the worst month for the NASDAQ since the Financial Crisis, and worst for the S&P 500 since 2020 during the Covid pullback. For April, the NASDAQ was down 13.26% while the S&P 500 lost 8.80% and Dow down 4.91%. For the week crude oil rose 3%, the dollar had another strong week and continues its rise, increasing 2.2%, the 10-year Treasury was flat, finishing at 2.89%, while the major U.S. indices finished as follows: Dow -2.47%, S&P 500 -3.27%, NASDAQ -3.93%, and Russell 2000 -3.94%.
Recent Economic Data
- Durable goods orders, a major input to factory orders that indicates company’s fixed investments and an input to GDP, rose 0.8% in March, right around expectations and rebounding from a 1.7% decline in February. Transportation is a volatile component mainly because of aircraft and auto orders which are large purchases, the index excluding transportation was up 1.1%, doubling expectations. Orders are up 10.2% from a year ago, while orders excluding transportation are up 8.9%. In addition, unfilled orders stood at a record high after rising another 0.4% in March, and 8.3% over the past year.
- The S&P Case-Shiller Home price index shows house prices rose 1.9% in February for the fastest monthly increase on record, reflecting an annualized rate of 22.8%. Prices re-accelerated from recent months with the increase from a year ago at 19.8% after a 19.2% and 18.9% increase in the prior two months, for the third highest y/y gain ever. Phoenix and Tampa, with 32.9% and 32.6% y/y gains, remain the hottest markets, while Minneapolis, Washington, and New York remain at the bottom (rising 12.0%, 11.9%, and 12.9% respectively). Cleveland remains near the middle with a 13.6% y/y increase.
- New home sales, one of the more volatile housing reports, fell 8.6% in March to an annualized rate of 763,000 homes, near expectations of 772,000. Compared to a year ago sales of new homes are down 12.6%. The drop could be due to a variety of reasons, including higher rates, higher sale prices, and the limited inventory of new homes as builders struggle to keep up with demand. Inventory of new homes grew by just 15k, but because of the slower sales rate the months’ supply of new homes was 6.4 in March compared to 5.6 in February. However, the inventory includes homes that are still under construction or not started yet. The median sales price of a new home is 21.4% higher from a year ago at $436,700.
- Jobless claims for the week ended April 23 declined 5k to 180,000 for a four-week average of 179,750. Continuing claims were 1.408 million, a new 52 year low, while the four-week average was 1.455 million, also a new 52 year low. The near record low jobless claims also suggest we are not in a recession.
- The personal income and outlays report shows personal income rose 0.5% in March, slightly ahead of the 0.4% consensus estimate, and down slightly from a 0.7% increase in February (revised up from 0.5%). The increase was widespread between wages, farm income, income from assets, and government benefits. However, the increase was mostly driven by the most important category wages and salaries which were up 0.6% in the month and are up a very strong 11.7% from a year ago. According to this report, real wages are up 3.2% when adjusting for inflation.
- Meanwhile, personal consumption rose at a very strong 1.1% rate in the month, almost doubling expectations. In addition, the prior month saw a strong upward revision, rising 0.6% versus the initial estimate of 0.2%. Spending on durable goods (typically large purchases like cars and appliances) fell 1.0% while spending on nondurable goods increased 2.5%, and service spending rose 1.1%. Compared to a year ago spending is up 5.5% while real spending, adjusting for inflation, is down 3.0%.
- The quarterly employment cost index shows compensation costs rose 1.4% in the first quarter, above the 1.1% increase expected, driven by a 1.2% increase in wages and salaries and a 1.8% increase in benefits. Wages and salaries rose 4.7% from a year ago and is a closer match to the 5.6% increase in wages according to the monthly labor report, however reflects real wages are declining by 3.8%.
- United Airlines said it plans to offer more flights across the Atlantic this summer, an indication it seems international travel picking up in the years ahead. It said it plans to increase its passenger carry capacity by 25% over pre-pandemic levels.
- Spirit Airlines said it has rejected a $3.6 billion cash takeover offer from JetBlue, saying the offer was not a superior proposal to Frontier Airline’s offer and that a deal likely could not be completed, sticking with its plans to merge with Frontier. JetBlue offered to increase its purchase to $33/share but Spirit said there was too much risk regulators would reject the merger, even after JetBlue said it would shed assets in effort to win approval. Frontier’s offer was $2.9 billion in a cash and stock deal.
- Twitter announced it would approve Elon Musk’s $54.20 per share, or about $44 billion, takeover offer to make Twitter private. Last week, Musk sold another $8.5 billion in Tesla shares to help fund his purchase, in addition to $25 billion in debt.
- U.S. Secretary of State Anthony Blinken said the strategy put in place offering massive support to Ukraine and pressure against Russia is causing Russia to fail. The U.S. is providing another $322 million in military financing to help Ukraine, bringing the total support to $3.7 billion since the war started. In addition, President Biden requested Congress approved $33 billion in new aid for Ukraine to provide support for the next five months. Meanwhile, due to the countries refusal to pay in Russian rubles, Russia blocked gas supply to Poland and Bulgaria, sending natural gas prices in Europe up 15% at one point last week. Supply was eventually resumed, but Russia continues to threaten the nations.
- Following several meetings in the White House, President Biden and the administration have signaled a much broader level of student loan forgiveness than previously discussed, which could be announced soon. There are still numerous headwinds before anything happens, including support, legal objections, and the level of forgiveness. As of now it seems a forgiveness of $10k is most likely, which would cost taxpayers $321 billion, but discussions have been as high as $50k per borrower, which would cost $904 billion. There are also discussions on income limits on forgiveness, new income-based repayment plans, new 0% loans for low-income borrowers, and another extension of the current moratorium which pauses payments and interest accrual. Timing is critical as the administration is looking to gain support ahead of the midterm elections.
- Fidelity, the largest 401k plan administrator with over $2.7 trillion in 401k assets, will become the first major provider to offer plan participants the chance to invest in Bitcoin. To do so, each plan sponsor would need to open a separate account for their employees that would hold Bitcoin and other short-term money market instruments for liquidity. Fidelity plans to cap the amount a participate can invest in Bitcoin at 20%, although plan sponsors can make that amount lower. This may see push back from the Department of Labor, who said in March plan sponsors should “exercise extreme care” before adding cryptocurrency as a plan option due to its volatile nature and its exposure to theft and fraud. It plans to investigate plans with this offering.
- China is appearing more open to bringing an end to its crackdown on internet companies in effort to help its slowing economy. The South China Morning Post reported the government plans to hold a symposium with the largest tech companies to discuss the changes. Also, relating to the concerns of delisting Chinese companies listed on U.S. exchanges, Bloomberg reported the Chinese government is holding discussions with American regulators on how to hold on-site audits of Chinese companies the U.S. is cracking down on.
Did You Know…?
Americans’ Savings Are Declining:
The personal saving rate, personal saving as a percentage of disposable personal income or in other words income that is left over after spending and paying taxes, dropped to 6.2% in March for its lowest level of the pandemic. In fact, it was the lowest saving rate since 2013, indicating consumers are spending a larger portion of their incomes and that the pandemic driven savings boom is over. This could be due to several factors. One, consumers built massive savings over the pandemic due to lack of things to spend money on due to shutdowns along with the government’s multiple stimulus packages. This may suggest the consumer is spending down their savings after years of building it. The saving rate averaged 18% from the beginning of the pandemic to mid-2021, reaching an all-time high of 33.8% in April 2020. Also, things are becoming more expensive due to rising costs and higher inflation, forcing Americans to spend more on necessities and other items. At this pace, it is expected the excess pandemic savings will be exhausted in 2023. With real incomes declining 3.5% (wages up 5% but inflation at 8.5%), consumer will be forced to use more savings if they want to keep their spending the same. This will be something to keep an eye on as the economy begins to slow.
The Week Ahead
The first week of the new month will bring another busy week of earnings reports and economic data releases. On the economic calendar the highlight will surely be the April labor report on Friday where the consensus sees about 400,000 job gains. Monday will include the PMI and ISM manufacturing indexes on activity and construction spend numbers for March, Tuesday will see factory orders, an indication of business investments, and the job opening and labor turnover survey. Wednesday may be the most important day of the week because the Federal Open Market Committee (FOMC) will be announcing its latest policy decision which the markets expect a 50 basis point rate increase along with the start of quantitative tightening, or the reduction of the Fed’s balance sheet. Like always, most attention will be placed on Powell’s Q&A and the path of future rate hikes. Other data includes weekly jobless claims and productivity and costs report on Thursday. In addition, OPEC will hold its monthly meeting, where a recent report suggests it could raise production, but we believe they will maintain current quotas. There will be plenty of earnings reports, with at least 30%, or approximately 150 S&P 500 companies reporting. Highlights include Expedia, MGM, and NXP Semi on Monday, AMD, Airbnb, Hilton, DuPont, BP, Pfizer, and Starbucks Tuesday, CVS, eBay, and Uber on Wednesday, Shell, Shopify, DoorDash, and Anheuser-Busch on Thursday, and Under Armour on Friday.