"Q2 2022 - Still Not Dead...."
By: Joseph R. Tranchini, CFA
GROSS DOMESTIC PRODUCT
- Aggregate GDP cataloged a modest contraction of -0.9% (SAAR) in Q2 2022. Q2’s contraction of -0.9% is a slightly better reading than the prior quarter’s contraction of -1.4%. This marks the second consecutive quarter of Real GDP contraction, which by some definitions would technically constitute a Recession. Important to note, declarations of Recession are, by their nature, purely subjective labels and are not meant to be taken as absolute. Much debate exists around current Recessionary declarations1,2
- Personal Consumption, the largest portion of GDP, remained positive in the quarter, having grown at a pace of 1.0%. Although still positive, this quarter marks a slight slowdown from the prior quarter’s growth rate of 1.8%. In Q2, a contraction of -4.4% in Goods Spending was largely offset by an expansion of 4.1% in Services Spending. Within Goods Spending, demand erosion was felt on Gasoline spending which contracted by -8.5% in the quarter, largely reflecting consumer pushback of higher prices. Within Services Spending, Food Service & Accommodation spending was a standout in the quarter, having expanded by 13.5%1,2
- The Private Investment component of GDP contracted at a pace of -13.5% in Q2 2022. The decline in Private Investment was heavily influenced by a slowdown in Inventory Spending, which is historically the most volatile part of the Private Investment component. Additionally, contractions were also felt across Residential and Non-Residential Investment categories of -14.0% and -0.1% respectively. Within Residential Investment, both Single-Family and Multi-Family structure spending contracted, with each declining by -4.2% and -5.6% respectively as higher interest rate affected affordability. Within Non-Residential Spending, Software Investment remained a bright spot having grown at a pace of 9.2%.1,2
- Net Exports
- Net Exports surprised to the upside in the quarter, having contributed positively to GDP growth for the first time since Q2 of 2020. This also marks the first time since Q2 2020 that the U.S. Trade Deficit did not reach a new all-time high, this is despite the U.S. Dollar being abnormally strong over this period of time. The positive surprise in Net Exports was driven by a large increase in U.S. Exports of 18.0%, which was uniformly comprised of large gains from the Export of both Goods and Services. Exports of Goods grew at a pace of 15.6%, while Exports of Services grew at a pace of 24.2%. U.S. Imports grew modestly in the quarter by 3.1%.1,2
- Government Spending contracted in the quarter at a pace of -1.8%. Federal Government spending was down by -3.2%, and State & Local Government spending contracted by -1.2%1,2. Within Federal Government spending, Non-Defense expenditures contracted the most by -10.5%, with Defense Spending growing modestly by about 1.0%. This marks the third consecutive quarter of contraction in the Government Spending component of GDP1,2
- The Unemployment Rate for the U.S. Economy is now at a level of 3.5%, which is now equal to 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
- The U.S. Labor Force has stagnated since the start of 2022, stabilizing around a level of 164M workers. Given the country’s age distribution of the population, this may be an indication of the maximum potential Labor Force at present time1,3
- Even still, 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 158.3M, 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 5.7M. This is exactly in-line with where the U.S. was operating at immediately before Pandemic lockdowns in early 20201,3
- Weekly Initial Claims for Unemployment Insurance have edged upward from prior all-time lows experienced in March of 2022. The Current Initial Claims reading came in at a level of 260K1,3
- Despite edging upward slightly over the past quarter, Weekly Initial Claims are still relatively in-line with Pre-Pandemic levels1,3
- Continuing Claims for Unemployment Insurance have held steady and are now at a level of 1.41M1,3
- Continuing Claims are still below Pre-Pandemic levels and have not edged upward commensurately with Weekly Initial Claims, an indication that the increase in Weekly Initial Claims applications are not translating into actual payment of Unemployment benefits1,3
- Both Headline & Core Inflation remain elevated far north of the Federal Reserve’s asymmetric 2.0% annualized target rate1,4
- June’s reading for Headline Inflation came in at an elevated pace of 12.0% (SAAR). That marked the highest month for Headline Inflation since September of 2005. June’s reading of 12.0% represents a significant acceleration from May’s elevated reading of 7.2% 1,4
- However, June’s reading for Core Inflation was significantly lower than its Headline counterpart, coming in at a slower pace of 7.4% (SAAR). June represented the highest pace of Core Inflation since April 2021, in addition to an acceleration from May’s reading of 4.3%. Higher Core Inflation in June was primarily attributable to large increases in Utility and Transportation related costs.1,4
- 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 Goods 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 continue to far outpace that of Services1,4
- Goods Inflation for the month of June came in at a rate of 20.0% (SAAR), an acceleration from the prior month’s elevated reading of 11.0%. The acceleration was primarily caused by increases in Gasoline & Energy Goods of 215%, as well as increases in Food Costs of 12.5%1,4
- Services Inflation in June was far below that of Goods Inflation, coming in at a pace of just 8.1% (SAAR). In the month of June, and for multiple trailing months, Utilities and Transportation Costs were the primary drivers of elevated Services Inflation1,4
- Market Expectations of future Inflation remain historically elevated, but have recently receded and remain much lower than that of actual Inflation levels5,6
- Market Expectations for Inflation over the next 5yrs are hovering around the 2.70% mark, whereas market expectations for Inflation over the next 10yrs are coming in at a level around 2.50%5,6
- Market Expectations for future Inflation have receded by a moderate amount from their prior highs around March of 2022, a potential indication that the market expects future inflationary pressures to abate substantially5,6
FORWARD LOOKING ASSESSMENT
How does one really know that they are sick? A seemingly simple question to answer when taken at face value, but one that may require a more pensive approach when further analyzed at a deeper level. While I am infinitely unqualified to make an actual medical assessment on this topic, allow me to at least render a few suggestions. You may be able to tell you are sick by the temperature your thermometer reads. You may be able to tell by whether or not you have a headache, or possibly a cough. Maybe you can even tell just by the general way you feel. Or perhaps, you can rely on someone with a high level of professional expertise on the matter to make the assessment for you. Unfortunately, this is not a medical journal, it is an investment article. That being said, the parallels between the two worlds are actually not all that different, especially in the context of determining the “health” of the Economy. So, break out your stethoscopes and get your calculators ready, because that is exactly what we will be doing over the next few paragraphs…
Addressing the elephant in the room, is the technical definition of a Recession 2 consecutive quarters of negative GDP growth? Yes… it is. Did we just experience 2 consecutive quarters of negative GDP growth? Yes… we did. So, are we in a Recession? By the technical definition… yes. However, the current economic environment is not really all that consistent with what you would expect a recession to look like when taking a more comprehensive look at the situation. In fact, the Federal Reserve is not even willing to characterize our current situation as a Recession. Why then is this the case? In essence, the Labor Market.
Right now, the Labor Market is widely considered to be operating at Maximum Employment levels. Stated differently, anyone who actually wants to work can find work. Given that backdrop, it seems rather contradictive that in such an environment where not only is employment bountiful, but where wages are also increasing, we would be inside of the ‘economic furnace’ that is a Recession. Let’s think about why businesses hire people in the first place. Businesses need people to help fulfill demand. When demand is strong, businesses employ more people, leading to high levels of employment across the economy. High levels of overall demand lead to high levels of employment, which is where we currently reside in this roadmap of economic events. One of the hallmark characteristics of an authentic recession would be a strong pullback in overall demand, and since we are seeing the exact opposite of such an occurrence, this would make declaring our current situation as a ‘genuine’ Recession somewhat of a puzzling proposition. To reconcile this situation with my previous metaphor I would proclaim the following….
Our thermometer tells us we are sick (2 quarters of negative GDP growth), but we do not actually feel sick (Maximum Employment levels).
While our Economy may not actually feel sick, it is most likely not feeling 100% healthy either. Why might this be the case? Everyone’s dear friend…. Inflation.
It is true that Inflation has remained stubbornly high for some time now, it is also true that this is unimaginably annoying for anyone who buys things (…which is everyone). The reason why Inflation has remained higher than expected, for longer than expected, has changed materially since the onset of our inflationary woes at the end of 2021/early 2022. Initially, Inflation was uncharacteristically high because of supply-chain disruptions attributable to widespread labor shortages that permeated all crevices of the Economy. This situation has gotten better. However, just as this situation was getting better, it was replaced by another very large source of inflationary pressure…. The Russia-Ukraine conflict. This conflict has created brand new supply chain problems which replaced the original/improving issues we initially faced.
In other words… it is the same mask (Inflation) but someone else is wearing it.
The good news is that with recent geopolitical developments such as the agreement allowing for safe passage of grain, as well as lowered expectations for a European natural gas embargo, this new culprit of inflation may have their days numbered. In fact, many Commodity prices have already materially retreated from prior highs, and at present time look a lot more ‘normal’ than they did at the start of this year. Another potential sign for relief on the horizon.
To recap our metaphorical approach to economic analysis, the Economy’s thermometer (GDP growth) is telling us that the Economy is technically sick. However, the Economy does not actually feel sick (Maximum Employment). Additionally, the professional experts on the matter (the Federal Reserve) are also telling us the Economy is not currently sick. With that in mind, where do we go from here? It is not unreasonable to expect a mild/non-uniform pullback in employment levels within specific areas of the economy as those areas renormalize to more historical activity and pricing levels. Additionally, Fed policy is likely to remain in neutral, to slightly restrictive, territory throughout the year. Inflation, although stubbornly high and immensely annoying, is showing early signs of abating, and it would not be unreasonable to see a more average-looking inflationary picture by year end. Granted, a general return to economic normalcy is not the most ‘exciting’ prognostication to ever be levied by a financial processional. However, that does not make it impossible.
[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.
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.
- FactSet. “Economics – Country/Region – United States”. August 2, 2022.
- Bureau of Economic Analysis. “Gross Domestic Product, 2nd Quarter and Year 2022 (Advance Estimate)”. August 2, 2022.
- Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. August 2, 2022.
- Bureau of Economic Analysis. “Personal Income”. August 2, 2022.
- FRED. “5-Year Breakeven Inflation Rate”. August 2, 2022.
- FRED. “10-Year Breakeven Inflation Rate”. August 2, 2022.