“Q1 2022 - Singing in the Rain"
By: Joseph R. Tranchini, CFA
GROSS DOMESTIC PRODUCT
- Aggregate economic growth unexpectedly recorded a modest contraction in Q1 2022, having receded -1.4% (SAAR). This represents a large divergence from the prior quarter’s elevated growth rate of 6.9%. This quarter’s contraction is largely believed to be the result of international trade and government spending related effects and is likely drastically understating the current strength of the U.S. Economy1,2
- Personal Consumption, by far the largest segment of the economy, experienced an acceleration in growth during Q1 2022. In the current quarter, Personal Consumption grew at a pace of 2.7% (SAAR), which marks the second consecutive quarter of accelerating growth in the economy’s biggest segment. The acceleration primarily came from increased spending on Services, which grew at a pace of 4.3% in the quarter, up from 3.3% in the previous quarter. Spending on Goods during the quarter was largely stagnant, coming in at -0.1% (SAAR). Within Goods, spending on Durable Goods grew at a pace of 4.1% which offset a contraction Non-Durable Goods spending of -2.5%. The contraction in Non-Durable Goods spending was primarily driven by a demand-erosion pullback in spending on Gasoline & Other Energy Goods of -15.1%1,2
- Private Investment grew at a pace of 2.3% (SAAR) in Q1 2022. Although Private Investment continues to expand at a positive rate, Q1 2022’s growth rate of 2.3% represents a large deceleration from the prior quarter’s reading of 36.7%. The deceleration appears to be solely attributed to a reduction in Inventory Spending, a traditionally highly volatile line-item in the Private Investment Segment of GDP. However, Non-Residential Fixed-Investment did grow at a robust pace of 9.2% on the back of strong investment in Equipment and Software. Residential Fixed-Investment also continued to grow at a positive rate, coming in at 2.1% due primarily to strong investment in Single-Family Homes1,2
- Net Exports
- Net Exports was the primary component of GDP that led to an aggregate contraction in growth for the quarter. Contractionary effects were both experienced by Exports, which slumped at a rate of -5.9% in the quarter, as well as by Imports, which ramped up by an abnormally large amount of 17.1%. The U.S. Trade Deficit reached an all-time high of -$1.54T in the quarter. This marks the seventh consecutive quarter that the U.S. Trade Deficit has breached a new historically high level, undoubtedly being propelled by a historically strong U.S. Dollar1,2
- Government Spending also contracted in the quarter, coming in at a rate of -2.7%. Spending contractions were exhibited across all levels of government during the quarter. Federal Government spending decreased at a rate of -5.9%, which was dragged down by decreases in National Defense spending of -8.5%, as well as by a contraction of -2.2% in Non-Defense spending. State & Local Government spending contracted at a rate of -0.8% in the quarter. This marked the second consecutive quarter that Federal and State & Local Government spending produced contractionary effects1,2
- The Unemployment Rate for the U.S. Economy is now at a level of 3.6%, which is not meaningfully far away from Pre-Pandemic levels of 3.5%1,3
- The Federal Reserve now considers the U.S. Economy to be operating at levels that are consistent with its overarching goal of Maximum Employment1,3
- Over the past few quarters, the U.S. Labor Force has continued to show significant improvement. The U.S. Labor Force is now at 164M, which is up considerably from the Pandemic low of 156.4M1,3
- Prior to the Pandemic, the Labor Force was comprised of 164.6M individuals. At present time, there is not a material difference in the Labor Force relative to Pre-Pandemic times1,3
- The number of Employed Individuals in the U.S. Economy is now at 158.1M, not meaningfully far away from Pre-Pandemic levels of 158.9M1,3
- The number of individuals who are formally considered Unemployed is now at a level of 5.9M, roughly a 200k difference from Pre-Pandemic levels of 5.7M1,3
- Weekly Initial Claims for Unemployment Insurance have continued improve and hover around all-time lows. The Current Initial Claims reading came in at a level of 200K1,3
- Initial Claims are now in-line with Pre-Pandemic levels1,3
- Continuing Claims for Unemployment Insurance have also continued to improve and are now at a level of 1.38M1,3
- Continuing Claims are now below Pre-Pandemic levels, and are also at the lowest level since 19701,3
- Both Headline & Core Inflation remain elevated far north of the Federal Reserve’s asymmetric 2.0% annualized target rate1,4
- March’s reading for Headline Inflation came in at an elevated pace of 10.9% (SAAR). That marked the highest month for Headline Inflation since September of 2005. Headline Inflation has remained above 6.0% every month since October 20211,4
- However, March’s reading for Core Inflation was significantly lower than its Headline counterpart, coming in at a much tamer pace of 3.6% (SAAR). Core Inflation readings have shown consistent moderation since December 2021, a sign that general inflationary pressures may be starting to moderate in certain areas1,4
- The Recent divergence between the Headline and Core Inflation readings can be largely explained by widespread and significant price increases in Energy-Related Goods, as well as Food1,4
- Recent Inflationary pressures for Energy-Related have derived from continued supply-chain issues plaguing U.S. Oil & Gas producers. Domestic production of oil has still yet to normalize back to pre-pandemic levels, creating supply-side pricing pressures1,4
- A primary driver of Food Inflation has been upstream price increases and supply shortages of various Fertilizers. These pricing pressures appear to have been exacerbated by the Russian Invasion of Ukraine, as Russia is a top global exporter of Fertilizers1,4
- In terms of Goods Inflation versus Services Inflation, pricing pressures in Goods continues to far outpace that of Services1,4
- Goods Inflation for the month of March came in at a rate of 22.9% (SAAR), an acceleration from the prior two months’ readings of 13.2% and 10.6%. The acceleration was primarily cause by increases in Energy Related Goods1,4
- Services Inflation in March was far below that of Goods Inflation, coming in at a pace of just 5.0% (SAAR). Over the past 2 months, Transportation costs have risen by 45.1% and 14.8%, a primary driver of Services Inflation1,4
- Market Expectations of future Inflation remain historically elevated, however are much lower than that of actual Inflation5,6
- Market Expectations for Inflation over the next 5yrs are hovering around the 3.24% mark, whereas market expectations for Inflation over the next 10yrs are coming in at a level around 2.86%5,6
- Both 5yr & 10yr measures of Inflation expectations are near their respective all-time high marks5,6
FORWARD LOOKING ASSESSMENT
Stop me if you have ever heard this one before…. “Get ready, because the bad times are coming”, or how about “We’re due for some bad news, I can feel it”, or my personal favorite “This time I really mean it, things are going down”. We may have experienced various shortages during the Pandemic, but one thing we are certainly not in short supply of is the ever-persistent Armageddonist. Waking up every day and claiming the sky is falling does not constitute an economic forecast, nor does it constitute actual sound financial advice, never has… never will. There has never existed a single day in all of human history where there has not been at least something to point to as potential cause for concern, and yet, seemingly against all the odds, the economy and markets have continued to push forward despite the presence of these shadowy apparitions that folks in the investment industry call ‘risks’. Nevertheless, it is important to understand not only where you’re at, but also where you’re going. So, with that being said, let’s take a brief trip down this quarter’s economic rabbit-hole and see not only where we stand, but which direction we are moving in.
I’m not sure if it would be possible to handcraft a more head-scratching set of economic data relative to what we got in Q1 2022. Aggregate economic growth actually contracted in the quarter, however by far the largest segment of the economy, Consumer Spending, actually saw positive growth accelerate to a new 3-quarter high. Even weirder still, the second largest part of the economy, Private Investment, also saw growth in the quarter. So, with the 2 largest segments of GDP experiencing growth, who was the culprit responsible for aggregate growth being negative? The short answer, the U.S. Dollar. The U.S. Trade Deficit reached a new all-time high in the quarter on the back of not only much higher Imports, but also from lower Exports as well. When the U.S. Dollar appreciates relative to other major currencies not only do foreign goods and services become cheaper for U.S. companies to buy, but American exports of goods and services become more expensive for foreign companies to buy. With the U.S. Dollar near 20yr highs relative to other major currencies, this doubled edged sword made both its marks on the U.S. economy in the recent quarter.
Cause for concern? Probably not.
I would not call growth in the 2 largest segments of the economy, occurring in tandem with significant employment gains, reason to sound the alarm bells. Rather, this quarter’s aggregate economic contraction was largely the result of trade-related crosscurrents that obfuscated the true underlying strength of the economy. In fact, regarding employment, many industries have even higher levels of employment now than prior to the start of the pandemic. In sum, not only are more people making money, but they are spending it too.
Our quarterly economic foray does not end there. What about Inflation?
Having to fight off stress-induced stomach ulcers every time you fill up your car’s gas tank is not an experience that many people want to persist. While Inflation has been historically high for some time now, I do believe it is important to understand that the forces causing Inflation over this time have changed in a big way. Initially, what we saw was a significant dislocation between the economic growth and the supply of labor. This detachment caused havoc at all points in supply chains across the economy as an asymmetric economic normalization left us with was supply-based inflationary pressures for many of the goods and services that we use on a daily basis. This labor dislocation has improved significantly since then, and there are signs that supply chains have healed substantially. For example, over the past 2 quarters business inventories have been sequentially increased, an effect that was noticeably absent in the early days of our current inflationary woes. But just as the labor supply issues have been turning around, a new inflationary force came into the fold, the Russia-Ukraine War. With the Russia-Ukraine conflict came 2 major inflationary effects, perceptions of oil & gas supply shocks, as well as global wheat and fertilizer shortages. Russia and Ukraine are the largest and fifth largest exporters of wheat, while Russia is the largest exporter of fertilizers. Just as inflationary pressures were subsiding elsewhere in the economy, Energy & Food prices soared in response to these two effects. This has produced an odd backdrop where Headline Inflation has accelerated, but where Core Inflation has actually moderated to tamer levels. With the expectation for eventual increases in domestic oil & gas production, as well as the adoption of alternative fertilizers, the Russia-Ukraine induced inflationary effects may prove to be short-lived. Important to note, that since inflation has been so high for some time, we are now getting into the territory of period-to-period changes experiencing progressively higher comparisons and therefore we could see a moderation in inflationary pressures simply due to the phenomena known as ‘base-effects’. Additionally, it bears mentioning that while costs for consumers have gone up over the past year, incomes have also risen as well. Personal savings remain elevated north of 2018 levels, and the average consumer’s balance sheet remains well fortified. So, while still exceedingly annoying, the worst of our inflationary troubles may be in the rearview mirror.
All in all, despite the extraordinary surplus of troubling narratives being persistently tossed around, the fundamental backdrop of the U.S. Economy remains strong and appears to be well poised to continue right along its trend growth path. Rainy days, even if they do actually come, do not stick around forever, and neither do opportunities in the investment markets. With that being said, I’ll leave you with one parting note to consider…. Who calls for rain more than the person selling umbrellas? Until next time…
[See Below for Disclosures & Annotations]
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
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- 1. FactSet. “Economics – Country/Region – United States”. April 28, 2022.
- Bureau of Economic Analysis. “Gross Domestic Product, 1st Quarter and Year 2021 (Advance Estimate)”. April 28, 2022.
- Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. May 6, 2022.
- Bureau of Economic Analysis. “Personal Income”. April 28, 2022.
- FRED. “5-Year Breakeven Inflation Rate”. May 4, 2022.
- FRED. “10-Year Breakeven Inflation Rate”. May 4, 2022.