If you were betting on a recession, today’s economic data signaled that you’re halfway to watching your scary scenario come true. Yes, gross domestic product went down.
And stocks went up. You’d initially suspect that this was another of those Wall Street convolutions where investors caught between two unpleasant outcomes bet on bad news . . . but that’s not really the case here.
The economy shrank at a 1.4% rate last quarter, setting the stage for a formal recession call if the erosion continues through the current quarter. That’s not usually good for stocks.
But a serious whiff of a recession should get the Fed to take note that the economy is cooling. We’ve seen what happens when the current policy board is forced to choose between supporting the job market and fighting inflation.
Every time, they’ve relaxed on rates to keep people employed. We’re feeling the inflation that results.
So in theory, a signal that the Fed has gone a step too far should buy us all a little relief from an aggressive interest rate cycle . . . slower and smaller hikes, maybe even a pause over the summer to let the results digest.
In that scenario, a bad quarter for the GDP would be embraced as eliminating a fear factor for stocks. Since we trade stocks and not the GDP, a scary scenario turns into good news.
However, that’s not actually what’s going on. When the bond and futures markets saw this news, interest rates actually went UP. Bonds sold off and rate futures locked in even greater conviction that we’ll see bigger tightening moves ahead.
The pivot isn’t huge, but it’s real . . . with big money backing it. Yesterday, the futures market priced in a 95% probability of a 0.50 percentage point hike next week. Today, those odds climbed to 96.5%.
Go farther out on the calendar and the results line up. Futures traders thought it was roughly a coin flip yesterday whether overnight rates would be around 2.50% by late September. Some bet on a slightly less aggressive glide path. A larger number were convinced that we’re in for even bigger hikes.
Today, the numbers shifted toward the aggressive end of the argument. Go out a year and compare the quotes from tomorrow to today, and it’s the same story.
This GDP report wasn’t balm for the rate doves hoping the Fed will be merciful. It was red meat for the hawks.
But you wouldn’t know that if you just read the headlines and saw stocks go up. You’d have to drill down into the data and measure the results, which is what I do all the time.
We’re more market scientists here than prognosticators. We look for correlation and causation.
And we test our experimental hypotheses to keep our investment logic in touch with reality. If our explanation model points in one direction and the market goes the other way, the model needs revision.
A model that lacks predictive power is useless. You’re just trading in the dark, then, only you think you know what’s going on.
So the economy shrank. Recession risk is up because we only need one more bad print in three months to hit that pain point.
Interest rates and interest rate futures went up, reflecting increased conviction from people with money that the Fed is going to step it up even faster than we thought a day ago.
The only thing that’s changed is this data release. And since higher rates are supposedly poison for stocks, we would expect stocks to be down . . . bad economy, rising rates, bad news either way you slice it.
But read the actual report. GDP shrank in real terms. That’s adjusted for inflation and inflation is running extremely hot.
In current dollars, the economy grew at a blistering 6.5% rate. We added $380 billion in activity last quarter.
Disposable income is up. Americans managed to put aside 6.6% of that income last quarter.
The government spent less because COVID relief programs expired. Nonetheless, people are working and earning more than ever.
Import costs jumped, which is no shock when commodity prices are soaring. Think oil. Think war in Ukraine disrupting global supplies.
And while you’re at it, think supply chains. Think COVID coming back to China. These are external shocks, things the Fed can’t control.
You subtract imports from GDP. A 17% surge on that line item will naturally be a drag on what’s happening in the domestic economy.
I know this can be boring stuff unless you’re a fan of statistical minutia like I am. But take a minute away from your screen and look outside.
Count the “help wanted, name your price” signs. Ask whether businesses closing near you are shutting down because they can’t find customers or because they can’t source labor and other inputs.
Talk to contractors. How busy are they? Can they get enough materials to finish all the projects on their plate? How far is their calendar packed?
What you discover is reality: America on the ground. That’s what ultimately drives the consumer economy, which is still 77% of the U.S. economy and the wellspring of the corporate profits that Wall Street loves.
Yes, we have inflation. Materials are expensive. Labor is expensive. But someone produces the materials and someone does the job . . . then they spend that money or invest it.
Inflation is the biggest distortion factor in this GDP number. Not the weather, like we usually see in a soft first quarter. Not the war in Ukraine, although it’s a factor.
In dollar terms, this is a boom. But those dollars are all 7-8% smaller than they were a year ago. They don’t stretch as far.
This is the kind of economy that rewards working dollars. Build a business. Get a hustle. Reach for a piece of the action.
Some areas of this economy are actually too hot for the Fed to handle. They saw this report and futures markets are flashing that it gave the hawks added ammunition.
I could drone on about these details all day, but want to leave you with one last note about how much the dollar shrank in the pandemic.
The economy today is 13% bigger than it was right before the pandemic struck. Factor out inflation and the two-year growth is more like 4% . . . a little progress, but not enough to make many people feel great.
Investors are still winning. It’s just a grueling process. I try to make it as simple, easy and fun as I can, but it still takes time and a little dedication to get results that matter.