"Q3 2022 - The Great Mirage"
By: Joseph R. Tranchini, CFA
GROSS DOMESTIC PRODUCT
- Aggregate GDP expanded at a pace of 2.6% (SAAR) in Q3 2022, breaking a two consecutive quarter stretch of negative growth and formally exiting the Technical Recession. Over the past three quarters, GDP has shown positive growth, despite two of the last 3 quarters being contractionary. Q3’s positive growth rate of 2.6% is above what many consider to be the long-term average growth rate of the U.S. Economy of 2.0%1,2
- The Consumption component of GDP, which comprises roughly 70% of the Economy, grew at a pace of 1.4% (SAAR) in Q3. This represents a stabilization of growth, as Q3’s growth rate of 1.4% is below that of the prior quarter’s level of 2.0%. However, Q3’s growth rate still came in above that of Q1 2022’s level of 1.3%. Consumer spending on Goods contracted in the quarter at a rate of -1.2%, which represents an improvement from the prior quarter’s contraction of -2.6%. The deceleration in contraction was uniformly driven both by Durable & Non-Durable Goods. Consumer spending on Services was positive in Q3, expanding at a pace of 2.8%, down modestly from the prior quarter’s reading of 4.6%, but still above Q1 2022’s level of 2.1%, signaling stabilization. Standout sub-level areas within the Consumption component include Motor Vehicles spending which contracted at a pace of -11.8%, as well as Transportation Service spending which increased at an elevated pace of 6.3%1,2
- The Private Investment component of GDP experienced its second consecutive quarter of contraction in Q3, declining by -8.5%, a modest improvement from the prior quarter’s contraction of -14.1%. Non-Residential Investment grew at a pace of 3.7% in the quarter, an acceleration from its prior quarter’s growth of just 0.1%. Non-Residential Investment acceleration was largely driven by Equipment investment which expanded at a pace of 10%. Residential Investment contracted in Q3 by a significant amount of -26.4%, accelerating from the prior quarter’s contraction of -17.8%. The abnormally large contraction in Residential Investment was primarily driven by housing market effects, as an overheated housing market has begun to cool off. Single-Family Home Investment contracted by -36.3% in the quarter, and Multi-Family Home Investment contracted by -5.5%. Q3 2022 marked the largest contraction in the Single-Family Home Investment sub-category since the Great Recession in 2008, as elevated home prices have collided with higher mortgage rates1,2
- Net Exports
- The U.S. Trade Deficit contracted in Q3 by -11.0%, contributing positively to GDP growth in the quarter. The contraction of the Trade Deficit was driven by both increases in Exports, as well as decreases in Imports, despite the backdrop of an abnormally strong U.S. Dollar. Export growth was seen across both Goods and Service Exports, with Goods Exports growing at a rate of 17.2% and Service Exports growing at a pace of 8.3%. Areas of note within Goods Exports included Petroleum Product Exports which grew at an elevated pace of 52.4%, the highest rate of growth for that segment since 2018. Q3 2022 marks the second consecutive quarter that the U.S. Trade Deficit retreated from its all-time high mark of $1.48T in Q1 of 20221,2
- The Government Spending component of GDP experienced its first quarter of growth in the past 6 quarters, expanding at a modest pace of 2.4%. The expansion of government spending was shared across both Federal Government spending and State & Local Government Spending. Federal Government Spending grew at a pace of 3.7% in Q3, which received a large bump from an expansion of National Defense Spending of 4.7% in the quarter. State & Local Government Spending grew at a pace of 1.7% in the quarter1,2
- The Unemployment Rate for the U.S. Economy is currently at a level of 3.5%. This level of Unemployment is largely considered by the Federal Reserve as representing Maximum Employment levels for the Economy1,3
- The current level of Unemployment is now equal to the multi-decade lows that were experienced prior to the Pandemic1,3
- The U.S. Labor force has also shown a strong rebound, currently standing at a level of 164.7M. This is the highest level the U.S. Labor Force has ever recorded in history1,3
- Upwards Wage Pressure has been seen as a primary factor in drawing individuals back into the labor force1,3
- Although, the U.S. Economy’s Labor Force Participation Rate is still below pre-pandemic levels. The current Labor Force Participation rate stands at 62.3%, down slightly from the pre-pandemic level of 63.4%1,3
- The number of Employed Persons in the U.S. Economy is now at a level of 158.9M. This is also the highest number of Employed Persons ever recorded in U.S. history1,3
- Additionally, the number of Job Openings available in the U.S. Economy currently stands at 10.7M, roughly 3M higher than during pre-pandemic times1,3
- At present time, there are about 1.84 Job Openings available for every Unemployed Person in the Economy. Throughout 2022, there have been more Job Openings per Unemployed Individual than in any other period in U.S. history1,3
- Average Weekly Earnings currently stand at all-time high levels, as Maximum Employment levels in the Economy have created upwards pressure on Wages1,3
- Wage Growth has been elevated in the post-pandemic period. Over the past 12 months (Sept 21’-22’), Average Weekly Earnings have increased by 12.56%, while PCE & CPI Inflation have increased by 6.2% & 8.2% respectively1,3
- Elevated Wage Growth has been effective in mitigating the effects of higher inflation levels over the past year1,3
- Both Headline & Core Inflation metrics remain elevated north of the Federal Reserve’s asymmetric average annual target of 2.0%1,4
- September’s reading of Headline PCE Inflation came in at a level of 4.1%, which represents a lower-than-average monthly reading since the start of 20211,4
- Alternatively, September’s Core PCE Inflation reading came in at a slightly higher level of 5.5%. Core PCE Inflation has surpassed Headline Inflation in recent months as Energy-related prices have retreated somewhat1,4
- Inflationary pressures were uneven between the Goods & Services top-line categories1,4
- Goods Prices deflated in the month of September at a pace of -1.2%, the third consecutive month of Deflation experienced in the category1,4
- Within Goods, the Durable Goods category experienced Inflation at a pace of 5.4%, whereas Non-Durable Goods deflated at a rate of -4.9%. Non-Durable Goods deflation was primarily attributed to lower Energy-related costs1,4
- Services Inflation expanded at a pace of 6.9%. A slight deceleration from the prior month’s reading of 7.1%1,4
- Services Inflation was largely driven by Transportation Services which inflated at a rate of 29.0%, as well as Housing & Utilities Services which inflated at a pace of 10.7% for the month1,4
- Market Expectations for future Inflation have receded from prior quarters, however, remain slightly elevated above long-term historically average levels5,6
- Market Expectations for future Inflation on a 5yr forward looking basis now stand at a level of 2.68%, while 10yr forward looking expectations are coming in at a level of 2.53%5,6
- Both 5yr and 10yr forward looking expectations have receded from their previous highs in March 2022, indicating that recent upticks in Interest Rates since then have not been driven by increasing Inflation Expectations, but rather Monetary Policy changes5,6
FORWARD LOOKING ASSESSMENT
Now you see me… Now you don’t
And just like that, the Technical Recession is over. Let’s take a tally of all the ‘terrible’ things that happened during this Technical Recession. Number of Net Jobs lost during the Technical Recession…. 0. No, in fact, we added a little over 2.9 million jobs during the Technical Recession. Additionally, the number of Employed Persons is currently at an all-time high.
What about job opportunities? Well, we reached a new all-time high level of job openings over the Technical Recession and are still currently operating at very lofty levels of outstanding openings. In fact, there are just under 2 Job Openings for every Unemployed Person in the Economy, another level consistent with all-time high levels the Economy has ever experienced. These levels are so lofty that the Federal Reserve has even made it a point to watch for them to come down as a measure of Monetary Policy effectiveness.
Surely GDP is in a bad spot, right? No, not really. Here is a running last three quarters of GDP growth from Q1 22’ to our most recent reported quarter, Q3 22’ (-1.60%, -0.60%, +2.60%). Chain those numbers together and you get a positive number. I may not have a Ph.D. in Mathematics but I’m fairly certain that means GDP is higher now than when we started the Technical Recession.
What about the Consumer, the lifeblood of the Economy? Personal Income, as well as Personal Spending, are both higher now than when the Economy entered the Technical Recession. Yes, Inflation has been stubbornly high and that is a difficult environment for low-income households who are not as able to benefit from Consumer Substitution effects as much as higher income households. That is troubling. However, a bright spot in that narrative is that Wage Growth has been more pronounced for individuals on the lower end of the income spectrum. This has been a beneficial, mitigating effect for those who have been more acutely affected by higher prices of everyday goods and services. As a reference to that notion, over the past 12 months Weekly Employee Earnings have increased by 12.56%, whereas Prices only increased by 8.2%.
Corporations must be hurting though, right? Again, no not really. S&P 500 Sales growth was over +17.00% for every quarter in the Technical Recession. As a reference, when comparing this figure to what Sales Growth looked like in a genuine recession (08-09’ Financial Crisis) we see that Sales growth was negative in that period, not double-digit positive.
My point is this… that was not Genuine Recession, it was a Mirage. Wherein it felt like there was something there, but when you go to take a look…. nothing.
That being said, the economy is in a unique position at present time. A cooling economy does not necessarily equal a broken economy. In a nutshell, that is pretty much where the economy currently is. Are certain areas of the economy cooling-off? Indeed, they are. However, were those areas of the economy abnormally hot to begin with? Yes, indeed they were. When looking forward, it would seem the relevant question to ask would be “Does the economy cool-off too much and throw us into a Genuine Recession?”. My subjective opinion on the matter is… no.
From a conceptual standpoint, a Genuine Recession would need to be accompanied by sustained/material contractions in Consumer Spending, and I believe that scenario is unlikely to occur without substantial Job Loss preceding it. Is substantial Job Loss in the cards then? In my view, no. Keep in mind where the economy currently stands regarding, the historically high number of Job Openings per Unemployed Persons metric. From the current elevated levels, it is unlikely that a moderation in employment to more historically average levels would carry with it the type of Consumer Spending contraction that would warrant a Genuine Recession; rather, it would constitute a normalization of an overheated economy more than a structural deterioration in the United States’ economic fundamentals. In other words, the economy is not succumbing to frostbite, its fever is cooling-off.
I will conclude this quarter’s commentary with a final parting note to consider. Even though at times it may feel like the economy is in a certain place, it is important to consider whether or not what is being felt is economic reality rooted in objective factual evidence, or just simply… a mirage.
[See Below for Disclosures & Annotations]
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- FactSet. “Economics – Country/Region – United States”. November 3, 2022.
- Bureau of Economic Analysis. “Gross Domestic Product, 2nd Quarter and Year 2022 (Advance Estimate)”. November 3, 2022.
- Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. November 3, 2022.
- Bureau of Economic Analysis. “Personal Income”. November 3, 2022.
- FRED. “5-Year Breakeven Inflation Rate”. November 3, 2022.
- FRED. “10-Year Breakeven Inflation Rate”. November 3, 2022