The Federal Reserve is set to hold its FOMC meeting next Wednesday to discuss the future direction of interest rates. Predictions indicate that the session may not bring any surprises. Fed fund futures suggest that the current rate of 5.25% is likely to remain unchanged for the foreseeable future.
This cautious approach seems wise, considering the ongoing ambiguity surrounding the economy. As previously mentioned, there’s a case for optimism as well as pessimism regarding economic indicators. In recent months, data has presented conflicting narratives.
Such contradictions are always common; however, they feel particularly critical at this stage of the economic cycle. Capital markets have been experiencing prolonged gains, yet signs of value are not abundantly clear, especially when analyzing risk spreads and earnings ratios relative to prices. If you believe that recent trends will persist, your best option may be to ride it out, embracing the capital gains as they come.
This is where the Fed comes into play, tasked with controlling inflation while stimulating economic growth and avoiding a recession. It’s no small feat, and the challenge may be insurmountable. Ultimately, it appears that the choice may lean toward economic stimulation over inflation management.
Evidence supporting this proposition can be found in the consistent growth of the M2 money supply, which we detail in the chart below. Since the beginning of the year, M2 has seen a nearly 7% increase annually as of April 9, although it has since moderated to 6.3%—the highest money-printing rate in over three years.
The upward trajectory of M2 this year implies that the central bank is intentionally injecting money into the economy in larger quantities, both in absolute and relative terms. But is this rapid growth rate of over 6% too aggressive? Some may argue that it is, especially since first-quarter GDP saw a nominal rise of just 5.3% (or 1.3% in real terms), per the Bureau of Economic Analysis.
The situation remains uncertain.
Recent economic data released this week presents a glimmer of hope—sort of, maybe, or perhaps.
Let’s begin with construction spending, which saw a modest 0.2% rise in March, according to the Census Bureau’s report on Monday. This marks the second consecutive monthly increase, reversing a year-long trend of stagnation or declines in construction spending. However, when viewed over the last 12 months, a 2% drop in construction spending compared to a year ago is one of the sharpest declines recorded, surpassed only by January’s slightly larger drop.
On a brighter note, disposable personal income continued to climb in March, rising by 0.7%—one of the strongest rates in recent memory, according to the Bureau of Economic Analysis. Regrettably, consumers seemed hesitant to spend their increased income. Personal consumption expenditures only grew by 0.3% in March, a mediocre figure that contrasts sharply with February’s robust 0.7% surge.
While the future remains uncertain, past trends provide a clearer picture. Unfortunately, historical data serves only as a rough guide when predicting future outcomes. Nevertheless, this historical perspective, combined with forecasts, may offer some insight, though investors must be prepared for any eventuality.
With this in mind, your editor examined past trends regarding equity market capital flows, volatility, and asset class correlations in the April issue of Wealth Manager. Though the findings are not groundbreaking, they offer valuable insights worth considering. We may not have direct answers, but we can’t overlook history. Whether these insights translate into actionable benefits will depend on the upcoming developments. Here’s what we discovered…
The economy is showing signs of a slowdown—a fact that is already well known. What’s new is the realization that the pace of this decline may be more pronounced than many anticipated.
This morning, the government revealed that the first quarter GDP grew at a mere 1.3% on an annualized basis, which is concerning for several reasons, especially as it falls significantly short of the previous quarter’s 2.5% increase. Notably, this 1.3% growth is lower than every quarterly change recorded since the first quarter of 2003. Market expectations were set considerably higher, with a consensus forecast nearing 2.0%, according to TheStreet.com.
Historically, when GDP growth dips this low, it signals troubling prospects for the future. The economy exhibits behaviors reminiscent of a stalled aircraft engine, risking further deceleration. This isn’t inevitable, but ignoring these signs would be unwise.
While today’s GDP report is merely the first of three assessments for the economy, allowing room for potential upward revisions, it’s necessary to acknowledge that consumer spending—the primary driver of the economy—is showing signs of aging. Although personal consumption expenditures (PCE) increased by 3.8% in the first quarter, it has declined from the previous 4.2%. While this isn’t a major issue at present, the question remains whether consumers are becoming reluctant to maintain their spending levels. For now, adopting a cautious approach seems prudent from an investment standpoint.
In today’s environment, every data point is scrutinized more than ever, as everyone seeks signs or clues about the economy’s trajectory. We know the economic cycle is mature—having continued for several years—but recent stock market behavior suggests that investors are confident in sustained growth.
Amid this backdrop, the latest weekly figures for initial jobless claims are promising. The Labor Department reported this morning that initial claims fell by 20,000 for the week ending April 14, marking the most significant decrease in over two months. This reduction surprised economists, who had anticipated a lesser decline of around 10,000.
In total, 321,000 individuals applied for unemployment benefits during the week ending April 14. While this figure is relatively standard, as claims have fluctuated between 300,000 and 350,000 for more than a year, there’s room for concern in the overall trend: the year-over-year percentage change in jobless claims has been trending upwards over time.
As illustrated by the chart below, the rolling 52-week change in new claims for unemployment is on the rise. While this metric is just one of many influencing the broader economic picture, it raises questions about whether the economy is in better shape than it was a year ago.
This morning’s update on durable goods orders presents some encouraging news for optimists. As a leading indicator of future economic activity, a strong performance in this sector suggests that a recession may be further off than previously thought.
The U.S. Census Bureau announced that new orders for manufactured durable goods rose by 3.4% last month, an improvement from a 2.4% increase in February. Notably, durable goods orders have risen in four of the past five months, as shown in the chart below.
Despite the recent positive trend, caution is warranted when interpreting these figures. Although durable goods orders are increasing, the gains often pale in comparison to the larger losses, which, while less frequent, tend to be more substantial.
The preliminary GDP estimate for the first quarter is expected to be released on Friday. The consensus forecast indicates a projected annualized growth of 2.0%, according to TheStreet.com. This figure would represent a decline from the fourth quarter’s 2.5%.
While a 2.0% growth rate wouldn’t be catastrophic, it comes on the heels of an 8.4% drop in existing home sales recorded in March, prompting speculation that economic growth may be slower than anticipated.
The current economic expansion has now lasted over five years. Recent comments by Fed Governor Frederic Mishkin suggest that the possibility of celebrating a sixth anniversary is quite real.
Mishkin remarked on Friday that the expansion appears to be transitioning to a more sustainable pace. “In looking ahead,” he noted, “I believe the most probable outcome for the coming quarters is continued moderate economic growth.”
However, one must reconcile Mishkin’s cautiously optimistic forecast with the fact that the yield curve remains significantly inverted. As of Friday’s market close, the benchmark 10-year Treasury yield stood at 4.67%, almost 60 basis points below the current Fed funds rate of 5.25%.
It’s possible that global stock markets may only experience a gentle slowdown rather than a sharp correction. While this may seem overly optimistic, a look at total returns across various regions suggests that a soft landing for equities could be feasible. One reason for this belief is the maintained high levels of liquidity and the presence of investing firms eager to seek bargains.
The total assets in mutual funds, ETFs, and hedge funds have reached unprecedented levels. Although this capital might be fickle across different sectors or countries, pools of cash eager for investment are not likely to disappear in the near future. The rapid growth of professional investment management over the years has resulted in a continuous influx of eager investors. This trend has taken decades to develop and is unlikely to dissipate quickly.
The Capital Spectator will be on break this week. Unfortunately, this time off will not feel much like a vacation. A recent storm in the Northeast has flooded my basement, leaving me with several inches of water to manage. Those who have dealt with similar situations know that such cleanup can be quite time-consuming. In essence, this week, Mother Nature takes precedence over market analysis for me. I hope to return to a semblance of normalcy next week. In the meantime, stay dry!
