"Q2 2024 - The Confidence to Jump"

GROSS DOMESTIC PRODUCT

• In Q2 2024, the U.S. Economy grew at a pace of 2.8% (SAAR) – an acceleration from last quarter’s growth rate of 1.4%. Q2 2024’s growth rate is the 4^th highest quarterly rate of growth for the U.S. Economy in the past 3 years, highlighting the resiliency of the economy in the face of various economic challenges. Additionally, over the past year the U.S. Economy has averaged an annualized quarterly growth rate of 2.9% which is a relatively significant margin above what many economists believe is the long-term trend growth rate 2.0%^1,2
  • Consumption
    • Consumer Spending – the largest component of GDP – accelerated in Q2 2024 to a level of 2.3% from last quarter’s growth rate of 1.5%. Consumer Spending growth was roughly equivalent across both Goods & Services categories. Goods Spending grew at a pace of 2.5% in the quarter, which was a sharp turnaround from the -2.3% contraction experienced in Q1 2024. Services Spending has been both robust and stable over the past few years, coming in at a pace of 2.2% in Q2 24. Within the Goods category, spending on both Durable Goods & Non-Durable Goods both reversed course from last quarter where each sub-category logged contractions of -4.5% and -1.1% – coming in at 4.7% and 1.4% respectively in Q2 24. Standout areas within the Durable Goods category included Motor Vehicle spending, which broke a 4 consecutive quarter streak of contracting growth by minting a 4.8% growth rate in Q2 24. Additionally, the Household Furnishings category saw a big gain of 6.8% – the highest reading for that category since the first half of 2021. Within the Non-Durable Goods segment, spending on Gasoline advanced by 6.2% in the quarter, reversing course from last quarter’s -11.6% contraction. Food spending resumed growth from last quarter’s modest contraction and came in at a steady level of 1.8%. The Services category experienced relatively positive/uniform growth in Q2 24, with some noteworthy areas of interest. Within Services, Health Care spending remains elevated and came in at a level of 4.0%. Transportation Services also increased by 4,0% in the quarter, marking the sub-category’s 5^th consecutive quarter of growth after a multi-quarter contraction streak. Food Service and Accommodation spending rebounded in a big way in Q2 24 and came in at a level of 0.9% – a big turnaround from the -3.3% contraction experienced in Q1.   ^1,2
  • Investment
    • The Private Investment component of GDP accelerated greatly in Q2 2024, coming in at a level of 8.4%, up from 4.4% in Q1. Positive growth was seen across both the Fixed Investment category as well as Inventory spending. Within Fixed Investment, Non-Residential Investment grew at a pace of 5.2%, up from 4.4% in the prior quarter, and Residential Investment contracted at a pace of -1.4%, cooling off from last quarter’s growth rate of 16.0%. Standout areas of interest in the Non-Residential subcategory included Equipment spending, which grew at a pace of 11.6%, up from 1.6% in the previous quarter, as well as Software spending, which came in at 6.6% in Q2 2024. Software spending has been substantially positive every quarter since Mid-2020, while averaging over 10% per quarter over the past 10 years. Structure spending on Manufacturing has also been a standout area in recent years, growing by about 90% since the start of 2023 due to heavy investment in semiconductor manufacturing capabilities. Within the Residential subcategory, Single-Family structure spending contracted by -5.6%, a cooling off quarter after having logged robust growth of 16.8, 13.7, and 27.3% over the prior 3 quarters. Multi-Family structure spending contracted by -3.2% in the quarter, marking the 3^rd consecutive reading of contractionary spending in the sub-category. Inventory spending contributed materially to overall growth in the Private Investment category during Q2 2024. Overall, 71.3B worth of provisions were added to inventories in the quarter, a large uptick from the 28.6B that were added in Q1. Changes in Inventory spending are a leading cause of variability within the Private Investment category.^1,2
  • Net Exports
    • In Q2 2024 the U.S. Trade Deficit rose to its highest level since Mid-2020, clocking in at -$1.0T – a relatively large uptick from prior quarters where the deficit was steady around the mid 900B level. In the quarter, both Imports and Exports grew, however the uptick in Imports was far greater than that of Exports, thus leading to an increase in the overall Trade Deficit. Exports rose by 2.0%, while Imports rose by 6.9% in the quarter. A standout area within the Imports category included Computers/Peripherals/Parts which has advance greatly over the past 3 quarters of 109.3%, 64.4%, and 32.3% respectively.  Standout areas within the Exports category included Travel which advanced by 10.3%, as well as Autos which broke a significant 2 quarter contractionary period by logging a 6.0% figure in Q2 2024. ^1,2
  • Government
    • Government spending accelerated in Q2, coming in at a pace of 3.1%, up from 1.8% in Q1. Federal Government spending advanced by 3.2%, up from -0.2% in the prior quarter. Federal Government spending was primarily bolstered by increased Investment spending, as well as Defense Spending. State & Local Government spending was steady in the quarter having grown by 2.6%, with a standout area of spending being Equipment Investment – which grew by 16.3% in the quarter.^1,2

 

EMPLOYMENT

• The Unemployment Rate for the U.S. Economy ticked upward in July and now stands at a level of 4.3%, up from the recent low mark of 3.7% in December 2023. Upticks in the Unemployment Rate have been mostly driven by a lower rate of growth in the Labor Force relative to growth in Unemployed Persons^1,3

• Regarding the Labor Force, we have seen a steady increase in the metric over the past few years and are now at an all-time high level of 168.4M^1,3
  • Higher levels of wage growth are an important factor driving growth in the Labor Force over the past year^1,3
  • The Labor Force Participation Rate remains below pre-pandemic levels and is now at 62.7%. Pre-Pandemic levels were roughly closer to 63%^1,3

• The number of Employed Individuals has remained stagnant over the past year, coming in at a level of about 161.2M^1,3

• A key metric monitored by the Federal Reserve, Job Openings, have moderated significantly over the past 2 years, which is largely seen as a positive sign from the Fed that the Labor Market is back in better balance. Job Openings are down to 8.18M from the all-time high mark of 12.18M achieved in 2022^1,3
  • There are now 1.13 Job Openings available for every unemployed personl^1,3
  • The number of Unemployed Persons currently stands at a level of 7.2M, an uptick from 6.1M seen at the start of the year^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 are up 2.8% over the past year^,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

• In June PCE Inflation grew at a pace of 0.9% (SAAR), and has averaged levels of 1.5% over the past 3 months, and 3.0% over the past 6 months. Q1 2024 saw elevated inflationary pressures relative to Q2. Q1 2024’s averaged inflationary reading came in at 4.5%, whereas Q2 has averaged just 1.5%.  ^1,4
  • Core PCE Inflation came in at a pace of 2.2% in the month of June, and has averaged a pace of 2.3% in the past quarter. For the YTD period, Core PCE Inflation has averaged 3.4%  ^1,4
  • Notable disinflationary pressures have been present in the economy relative to Q1 2024 when hotter-than-expected inflation readings surprised the economy and lead to Fed to delay the start of the Rate Cut Cycle^1,4

• Material differences continue to persist between Goods Inflation and Services Inflation, although both categories have generally experienced disinflationary pressures in Q2 2024^1,4
  • Goods Inflation has generally been low to contractionary in the past 3 months, having averaged a level of -1.3% over that time. On a YTD basis, Goods Inflation has averaged just 0.3% as a whole^1,4
    • The Durable Goods subcategory of Goods Inflation has experienced a large degree of deflation over the past 3 months, coming in at an average of -3.9% over the past quarter. Motor Vehicles have been the primary driver of deflation in the Durable Goods segment, having contracted by -4.4% over the past quarter. Another standout area within the Durable Goods segment has been Household Furnishings & Equipment which has averaged a contractionary rate of -7.2% over the past quarter. ^1,4
    • The Non-Durable Goods segment of Goods Inflation has averaged out to a relatively stagnant rate of inflation over the past 3 months, coming in at just 0.2% over that time. Gasoline & Energy Goods have been an area of robust deflationary pressures in Q1, dropping by an average rate of -11.6% – with significant interim variability. Food Inflation has been subdued over the past 3 months, coming in at an average level of just -0.2% while averaging 1.1% on a YTD basis. Clothing & Footwear experienced 2 consecutive months of deflationary pressures, and has averaged an inflation rate of 2.7% over the past 3 months.  ^1,4
  • Services Inflation has largely been the area of the economy exhibiting the more robust and persistent inflationary pressures over the past year. Over the past 3 months, Services Inflation has averaged a level of 2.9%, compared to a level of 5.8% during Q1 2024. ^1,4
    • Within the Services Inflation category, multiple areas standout as noteworthy. Household Utilities has experienced 3 consecutive months of deflationary pressures, having contracted by an average of -1.8% over that time. Rent has also been experiencing disinflationary pressures over the past 3 months, clocking in at an average level of 4.1% in Q2 – a moderate drop from the average rate in Q1 which was 5.0%. Transportation Services is another area where persistent deflationary effects have occurred over the past 3 months, averaging a level of -6.4% in Q2. Deflation in the Air Transportation subcategory of Transportation Services has been a large factor in driving overall price drops, with the subcategory logging deflationary readings of -12.7%, -17.4%, and -22.5% over the past 3 months. Travel Accommodation prices have also been an area of continued deflationary pressures in Q2, having experienced 3 consecutive months of deflationary reading of -20.7%, -1.1%, and -1.7%.^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

When thinking about how I was going to start this quarter’s forward looking assessment piece a couple of ideas came to mind as to how I would go about communicating how this recent batch of economic data aligns with the Fed’s (likely) soon-to-cut narrative.

Maybe its like a bird jumping out of its nest and flying out of a tree? Maybe its like taking leap of faith from a cliff into tropical waters? Perhaps something to do with ‘walking the plank’? Surely a metaphor about a space shuttle dropping back down into orbit would work, right? Nope – not even close to working, and here’s why.

Those metaphors all ‘fall-short’ by ‘falling-too-much’.

Much of the narrative in the financial news has been about when the Fed would cut rates, and by how much, and would they keep doing it, and of course whether it was the right thing to be doing. What tends to happen when we get into this way of thinking is that it becomes easy to create a subconscious dissection of 2 distinct realities (a high-rate environment, and a low-rate environment), but this could not be further from the actual reality of the situation. No, the rate cuts that are (likely) to occur this year won’t be metaphorically like jumping off a cliff in the Caribbean – instead, they’ll be more like the family dog getting off the couch onto the floor… Technically lower? Yes. Absurdly/accommodatively/free-money-era lower? No.

A question worth asking though is, what exactly changed from Q1 to Q2 which led the shift from the ‘data-is-not-cooperating’ paradigm to this new ‘soon-to-be-lower’ narrative? Well, in a nutshell, the data changed….again. Specifically speaking, Inflation went from averaging 4.5% (SAAR – measured monthly) in Q1 to 1.5% in Q2. Not only did the overall level of inflation cool-off from Q1 levels, but arguably more importantly was the change in the composition of inflation during this time. Relative to Q1, in Q2 we got outright deflationary pressures in Goods, while Services inflation (the most robust and persistent area of inflation) actually decreased by a substantial amount. Q1’s average for Service inflation was 5.8%, compared to Q2’s average of 2.9%. Being one of the more referenced parts of the inflation picture, it is likely that this compositional change in inflation was ultimately what gave the Fed ‘greater confidence’ to signal the beginning of the rate cut cycle.

However, the Fed looks at a great many variables and considerations when making policy decisions, not just inflation itself. So, let’s take a look at one of the more commonly referenced datapoints when it comes to labor market conditions – Job Openings. Yes, Job Openings have been a highly scrutinized metric in the current labor market environment and here is why. Previously, the Fed’s view was that the labor market had a supply/demand problem. Too much demand for workers, and too little workers to go around. This dynamic has produced one of the most beneficial developments for workers in the modern era, above usual wage growth. However, wage growth can be viewed as a double-edged sword of sorts. With more money comes more spending, and with more spending there is (likely – not for certain – but likely) increased demand-pull inflation. The reason why Job Openings are so scrutinized in this regard is that they are a direct measure of opportunity for workers, and in short, opportunity leads to wage pressure and wage pressure leads to inflation. This could largely be viewed as the second ‘piece of the puzzle’ the Fed was looking to see, a cooling labor market by way of lower Job Openings, which is exactly what we have got a drop of about -33% in the number of Job Openings from the all-time high experienced in 2022 down to a level that is now consistent with the trend growth of the economy.

Although that does sound a little morbid when I run that train of thought through my head, “We have lower inflation because of less opportunities available”; however, there is a bright spot of subtlety in that backdrop that while there are definitively less opportunities available out there, there has not been outright job loss at an aggregate level in the economy during this time. Dare I say ‘soft landing’?

So, as we move forward into the future, what are some things that we are likely to see? A few come to mind. In the past I’ve written about the potential break-out of price wars in some industries, and that is exactly what we’ve seen with larger retailers competing directly against each other by dropping prices to bring customers in (or back). I think that is a trend that will continue moving forward as a more-selective consumer will continue to vote with their wallet. Additionally, the rate cut cycle may not reach longer-term rates as directly as folks subconsciously think, which would mean financing costs could get modestly cheaper – but will be a far cry away from the free-money era of the post global financial crisis. Should these financing costs only drop by a modest amount, activity in the housing market may remain subdued as existing homeowners who are ‘locked-in’ to extremely lower mortgage rates cannot justify moving locations and switching out a historically cheap mortgage for one that is many multiples more expensive. Finally, I would largely expect consumers to continue spending at around historically normal levels as wage growth pressures normalize, which would loosely translate to a job market that is steady and more balanced, much like the labor market of 2016-2019. The bonanza-style hiring that many sectors engaged in during 2020-2022 (especially tech) is likely to be a mistake employers will be reluctant to make again, further guarding against the potential for a revamp of labor market supply/demand imbalances.

As the U.S. Economy (likely) takes its first step off the interest rate cliff, it is all but certain that new storylines and headlines will emerge – however we can move forward into this new era knowing that many of previous ‘dark clouds’ of the past few years show genuine signs of dissipating, potentially giving us a much clearer view from atop our current cliff to make that first ‘step-of-faith’ downward with confidence.

 

[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”. August 1, 2024
2. Bureau of Economic Analysis. “Gross Domestic Product, 2nd Quarter and Year 2024 (Advance Estimate)”. August 1, 2024.
3. Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. August 1, 2024.
4. Bureau of Economic Analysis. “Personal Income”. August 1, 2024.
5. FRED. “5-Year Breakeven Inflation Rate”. August 1, 2024.
6. FRED. “10-Year Breakeven Inflation Rate”. August 1, 2024.