"Q1 2024 - Following Breadcrumbs"

GROSS DOMESTIC PRODUCT

• In Q1 2024, The U.S. Economy grew at a seasonally-adjusted annual rate of 1.6%. Q1 2024’s reading marked a moderate slowdown from the prior two quarters’ readings which came in at 3.4% and 4.9% respectively. Important to note, Q1 24 represents the 7^th consecutive quarter of positive growth for the U.S. Economy. Additionally, Q1 24’s reading of 1.6% is still roughly in-line with what many believe is the long-term growth rate of the economy of 2.0%. Over the past several quarters there has been noticeable changes in the composition of economic growth^1,2
  • Consumption
    • Personal Consumption Expenditures, by far the largest segment of the economy, grew at a pace of 2.5% (SAAR) in Q1. Consumer spending on Goods and Services varied substantially in the quarter, with Goods Spending contracting by -0.4% and Services Spending increasing by 4.0%. Q1 24’ ended a 5 consecutive quarter streak of positive growth in Goods Spending. Within Goods Spending, Durable Good spending contracted by -1.2%, while spending on Non-Durable Goods stagnated. Within the Durable Goods segment, spending on Motor Vehicles & Parts experienced a large contraction of -9.0%, which marks the 4^th consecutive quarter of contractions in that category as high prices and high interest rates continue to hamper affordability. Within the Non-Durable Goods segment, standout areas included spending on Gasoline & Other Energy Goods which contracted by -11.0%, as well as Clothing & Footwear which expanded 5.3% in the quarter. Consumer spending on Services remains robust, continuing to accelerate for the 3rd consecutive quarter and clocking in at 4.0%. Areas of note within the Services segment include Health Care, Transportation, and Food Services. Health care grew by 5.5% in the quarter and continues a relatively long streak of higher-than-average growth dating back to mid-2020. Transportation Services grew by 4.7%, an acceleration from 4.2% and 0.9% in the last two quarters. Food Service & Accommodations contracted by -2.0%, the category’s largest contraction since Q1 22’; a potential sign of consumer substitution effects within the data. Economic growth in Goods and Services appears to somewhat mirror the inflationary effects in each category over the past several quarters in that Services has experienced higher growth/higher inflation, whereas Goods have experienced lower growth/lower inflation^1,2
  • Investment
    • The Private Investment component of GDP grew at a pace of 3.2% in Q1 24’, which marked a noticeable acceleration from the prior quarter’s growth figure of just 0.7%. Within the Private Investment section, Non-Residential Fixed Investment grew at a pace of 2.9%, a slight deceleration from the prior quarter’s reading of 3.7%. Non-Residential Investment was bolstered in the period by Manufacturing Investment which grew at a pace of 13.9%. Manufacturing Investment has been well above average growth levels since the passage of the CHIPS Act in late 2022. Private Investment in Software continues to be a high growing/low variability region of the economy. Software spending in Q1 24 came in at a pace of 11.3%, the category’s 3^rd consecutive quarter of accelerating growth. Residential Fixed Investment, as a whole, grew by 14.9% in the quarter, a large uptick from the prior quarter’s level of 2.8%. The large acceleration in Residential Investment came from Single-Family home investment which grew at an accelerated pace of 18.1%. Single-Family home investment has seen three consecutive quarters of double-digit growth, as developers build to capitalize on higher prices. Multi-Family home investment has contracted for the past two quarters and remains choppy. Overall inventory levels across the U.S. Economy expanded by 35.4B worth of provisions, a decrease from last quarter’s inventory additions of 54.9B. Across the U.S. Economy, overall inventory levels have been consecutively augmented each quarter since Q3 2021^1,2
  • Net Exports
    • The U.S. Trade Deficit expanded substantially in Q1 24’ clocking in at -973B. This is up significantly from the last quarter’s reading of -918B and also represents the first increase in the Trade Deficit since Q2 22’. The expansion of the Trade Deficit was entirely driven by an increase in Imports rather than a decrease in Exports. Imports increased by 1.7%, which was bolstered by higher imports of Computer and Peripheral Equipment, which came in just shy of an all-time high reading. Additionally, the increase in Imports was also buoyed by large increases in Internation Travel, which did come in at an all-time high reading in the quarter and has been historically high since the start of 2023. Exports were relatively stagnant in Q1, growing by just 0.2%.^1,2
  • Government
    • The Government component of GDP decelerated greatly in Q1 24’, coming in at 1.2%, the lowest rate of growth for the category in the last 6 quarters. As a reference, the prior 3 readings were 4.6%, 5.8%, and 3.3%. Federal Government spending in Q1 24 contracted slightly by -0.2%, which marks a drastic turn from the prior 2 quarters’ readings of 2.4% and 7.1%. A contraction in National Defense spending of -0.6% was experienced in the quarter, which appears to be mostly driven by a large contraction in National Defense Equipment spending of -18.8%. State & Local Government spending remained positive at a rate of 2.0% in the quarter, however this also represents a moderate deceleration from the prior two quarters’ readings of 6.0% and 5.0%. Deceleration effects for State & Local Government spending appear to have come from a large contraction in Gross Investment in Equipment, having decreased by -6.3% in the quarter ^1,2

 

EMPLOYMENT

• The Unemployment Rate for the U.S. Economy is currently at a level of 3.9%. This level of Unemployment is largely considered by the Federal Reserve as representing Maximum Employment levels for the Economy
• Over the past year, the Labor Force has seen a modest uptick. January’s Labor Force reading came in at a level of 168M, up from 166.8M one year ago^1,3
  • Higher levels of wage growth are an important factor driving growth in the Labor Force over the past year^1,3
  • Although the Labor Force has grown over the past year, the Labor Force Participation Rate remains below pre-pandemic levels, coming in at 62.7% compared to 63.3% in the pre-pandemic era.^1,3
• Over the past year the number of Employed Individuals has grown to a level of 161.5M, up from a level of 160.7M^1,3
• The number of Job Openings in the Labor Market have continued to moderate at a steady pace since reaching their all-time high at the start of 2022, a sign of normalizing labor supply/demand imbalances. There are currently 8.48M Job Openings ^1,3
  • There are currently 1.30 Job Openings available for every Unemployed Individual^1,3
  • The number of Unemployed Individual stands at 6.5M^1,3
  • Moderation in the number of Job Openings has been a key factor referenced by the Federal Reserve as a potential sign to begin Monetary Policy normalization via ceasing Rate Hikes, and potentially beginning a Rate Cut Cycle^1,3
• Average Weekly Earnings have continued to rise over the past year by about 3.30%, a continued sign of a strong Labor Market^1,3
  • Over the past year, Average Weekly Earnings increases have been entirely attributed to increases in Wage Growth as opposed to Hours Worked^1,3
  • Elevated Wage Growth, in tandem with consumer substitution effects, have been instrumental factors in allowing U.S. consumers to partially offset the effects of higher Inflation^1,3

 

INFLATION

• Headline PCE Inflation in the month of March was 3.9% (SAAR) and has risen by 2.70% over the past 12 months.^1,4
  • Additionally, Core PCE Inflation’s March reading came in at the same level as Headline inflation at 3.9%, while also increasing by 2.8% over the past 12 months^1,4
  • Over the past year, substantial progress has been made in reducing the rate of inflation; however, the economy has not experienced widespread deflationary pressures. Many areas of the economy are still dealing with stubbornly high prices and continued inflation. Pricing pressures do appear to be more varied in recent history^1,4

 

• There has continued to be material differences between inflationary pressures across Goods and Services. Goods have generally been experiencing stagnant/deflationary pressures, while Services have continued to experience upward pressure in prices^1,4
  • In the month of March, the Goods category experienced its second consecutive month of inflationary pressures after a four month streak of deflationary pressures, coming in at a level of 1.8%. The prior two reading were 6.1% and -2.0%^1,4
    • Durable Goods has been an area of varied deflationary pressures over the past year, but having mostly experienced deflationary pressures. Over the past three months Durable Goods inflation came in at levels of 0.8%, 2.2%, and 2.4%. However, over the past year Durable Goods have actually contracted at a pace of -1.9%. Within Durable Goods, New Auto prices have contracted for each of the last 3 months, coming in at levels of -2.1%, -1.3%, and -0.6%. Used Auto prices followed a similar pattern over this time, coming in at levels of -12.6%, 5.2%, and -34.2%.^1,4
    • Non-Durable Goods have also experienced varied inflationary pressures over the past 3 months, logging readings of 2.3%, 8.2%,and  -4.3%. As a whole, Non-Durable Goods have inflated by just 1.3% over the past year. Food inflation has varied over the past quarter with readings of -0.5%, 1.5%, and 5.8%, while having increased at a rate of 1.3% over the past year. As is usually the case, the Gasoline & Other Energy Goods category has experienced volatile pricing pressures over the past three months, coming in at levels of 18.8%, 49.8%, and -33.0%^,1,4
  • Services Inflation has proven to be the most stubborn area of continued inflationary effects in the economy, having experienced abnormally high/positive inflation every single month since the start of 2021. Strong consumer demand, as is evident from the GDP growth breakdown, appears to be a leading factor keeping pricing pressures high.  The 15-year median for Services Inflation is about 2.40%, and this figure has been exceeded almost every single month since 2021, having also increased by 4.0% over the past year^1,4
    • There have been many standout areas and trends within Services Inflation over the past year. Rent has remained one of the most stubborn areas of inflation across the economy, having increased by 5.8% over the past year, while experiencing relatively uniform and elevated pricing pressures over that time. Electricity costs have also risen by a historically large amount over the past year, coming in at a rate of 4.5%. Electricity costs are now at all-time highs and are roughly 32% higher than in 2019. Hospital & Nursing Home Services are also now at all-time highs, having risen by 3.4% over the past year. Car Insurance prices have been experiencing a large degree of inflationary pressures over the past year, rising by 8.0%. Restaurant prices of meals and beverages have also been experiencing steady/elevated pricing pressures, rising by 4.1% over the past year.^1,4
    • Service Inflation is largely cited as the primary issue responsible for overall price levels not experiencing outright deflationary pressures during the Fed’s current restrictive monetary policy posture.^1,4

 

• Market Expectations of future inflation levels have been extremely stable since the mid-point of 2022, a potentially welcome sign for the economy as expectations of future inflation have historically been closely correlated with actual inflation to come^5,6
  • Market Expectations for future Inflation on a 5yr forward looking basis are now at a level of about 2.25%, declining consistently from the previous high of 3.5% in March 2022^5,6
  • Market Expectations for future Inflation on a 10yr forward looking basis are now also at a level of about 2.3%, which have also declined from the previous highs achieved in March 2022^5,6

FORWARD LOOKING ASSESSMENT

While they may be the sole archnemesis of a clean kitchen floor, believe it or not, breadcrumbs may actually have some functional purposes. Granted, I’m referring to breadcrumbs of the metaphorical variety, not necessarily the actual physical variety which are, for the most part, useless (unless your goal is to attract ants…).

While I wouldn’t’ exactly advocate for replacing a good ole-fashioned compass with breadcrumbs anytime soon, I think it is rather safe to say most people are familiar with the use of breadcrumbs as a navigational tool from the all-time classic story Hansel & Gretel. Follow the breadcrumbs and they will lead you to where you need to go. It is an allegory that applies rather handsomely to the world of investment research as well. In a lot of ways, that is what we as researchers do, we look for clues, trends, and information then we ‘follow the breadcrumbs’ until we arrive at a conclusion that makes sense. So, without further ado, let’s jump into our quarterly economic journey amongst the breadcrumbs.

The first breadcrumb along our journey… the composition of economic growth. It is no secret that the consumer is the largest part of the economy, therefore what the consumer does is going to ultimately be the undercurrent of the economy. One useful lens through which to organize and analyze what the consumer has done is to break consumer spending into two categories, goods and services. When looking into the consumer spending growth data over the past 2yrs (measured quarterly using year-over-year growth figures) what we see is that the average rate of growth for Goods Spending is less than half of the growth in Services Spending over that time. Goods Spending growth averaged 1.3%, while Services Spending averaged 3.0% over that time. There are many potential explanations for why this quantitative finding is the way it is, one of which I think warrants significant consideration and leads us to our second breadcrumb along our journey.

Our second breadcrumb pertains to the notion that the modern consumer has a higher affinity for consuming experiences over physical things. In fact, a 20yr study out of Cornell University highlighted that consumers had higher rates of happiness after consuming experiences compared to material things across thousands of study participants⁷. Additionally, the proliferation of social media outlets giving rise to the concept of someone’s online identity being intertwine with their life experiences may have accelerated this trend significantly, particularly in the post-pandemic era. Couple this notion with the reality that consumers have experienced robust wage growth over this period and a more coherent picture begins to come together. Perhaps it is the case that consumers are taking their increased earnings and funneling them into purchasing experiences & services (dining out, traveling, concerts, medical procedures, etc.) rather than simply consuming more/higher quality physical goods.

So does the story end there? Not quite, we still have another breadcrumb to follow.

Our final breadcrumb leads us to everyone’s favorite economic trend of all-time… inflation. And yes, that preceding sentence comes with a extra-large side of sarcasm. The trademark trend within recent inflation figures has been the divergence between the rate of inflation in goods as opposed to services. Over the past few years Services Inflation has been noticeably higher than Goods Inflation. One might even go as far as to say that if Services Inflation looked like Goods Inflation over the past few years we may actually be in a state of outright Deflation across the economy (a wild hypothetical, I know). With the breadcrumbs that we have assembled so far it becomes much more clear as to what our current economic reality may be, and also where we are headed. Higher wage growth lead consumers to spend more heavily on things they desired/needed more, experiences. Higher spending on experiences has lead to outsized economic growth in service-related areas of the economy, as can be discerned from the prior GDP growth figures analyzed). With high consumer spending and high economic growth in these areas of the economy, the market did what it tends to do in these situations, it adjusts. That adjustment has appeared to come in the form of higher prices for these services (if you want to go with the term Demand Pull Inflation that would be warranted).

Moving forward there are a number of potential routes the economy could take with regards to our path towards normal inflation. Higher growth in service-related areas of the economy could theoretically lead to new entrants and increased competition in those areas, which could in turn eventually lead to lower prices, with sustained economic growth. Another possible outcome would be a more secular shift away from consumers preferring experiences over things, which could lead to a re-composition of demand away from services and an eventual re-balancing of inflationary pressures (although this outcome seems unlikely). Finally, we could ultimately enter into a period of time where consumers ‘tighten their belts’ to augment savings which could, in theory, have both deflationary and contractionary effects on inflation and growth alike.

As is always the case, time will tell where we eventually end up, but for all the uncertainty and crosscurrents present in today’s economy there is one ‘evergreen tree’ of a constant that remains… no matter what happens, there will be breadcrumbs to follow… and we will do just that.

 

[See Below for Disclosures & Annotations]

DISCLOSURES

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.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The companies presented here are for illustrative purposes only and are not to be viewed as an investment recommendation.

Tax laws and regulations are complex and subject to change, which can materially impact investment results. LPL Financial does not provide tax advice. Clients should consult with their personal tax advisors regarding the tax consequences of investing.

 

ANNOTATIONS

1. FactSet. “Economics – Country/Region – United States”. February 1, 2024
2. Bureau of Economic Analysis. “Gross Domestic Product, 4^th Quarter and Year 2023 (Advance Estimate)”. February 1, 2024.
3. Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. February 1, 2024.
4. Bureau of Economic Analysis. “Personal Income”. February 1, 2024.
5. FRED. “5-Year Breakeven Inflation Rate”. February 1, 2024.
6. FRED. “10-Year Breakeven Inflation Rate”. February 1, 2024.
7. Amit Kumar, et al. “Waiting for Merlot: anticipatory consumption of experiential and material purchases”. August 21, 2014