Fourth Quarter GDP Growth Slows, But Remains Strong
Photo Credit: Victor Freitas, Unsplash
Weekly Market Recap for January 26, 2024
This week, the US Bureau of Economic Analysis (BEA) reported price data for December. The Personal Consumption Expenditures (PCE) price index was up 0.2% vs. the 0.1% decline posted in November. On a yearly basis, the core PCE stepped up 2.9%, one-tenth of a point below the experts’ outlook and less than the 3.2% expansion reported for November.
The Fed will meet next week and decide whether to change the federal funds rate, which is currently 5.25%-5.50%. Economists and market analysts are not expecting any change. The Fed will review new housing and employment figures as it prepares to make its decision. More investors on Wall Street are coming to the realization that Fed cuts to short-term interest rates might be limited to only three one-quarter-point moves this year and not come until the second half.
Finally, we have seen solid corporate earnings releases this week that have continued to support positive investor sentiment.
S&P 500 Index (Last 12 Months)
S&P 500 Technical Composite (Last 24 Months)
4Q23 Initial GDP Estimate
In Q4 2023, U.S. GDP expanded at a +3.3% annual pace, a slowdown from Q3’s +4.9% but the second-strongest growth since Q4 2021. The real GDP increase reflected consumer spending on goods and services, exports, state and local government spending, nonresidential fixed investment, federal government spending, private inventory investment, and residential fixed investment. Compared to Q3, the deceleration in real GDP in Q4 reflected a slower pace of private inventory investment, federal government spending, residential investment, and consumer spending. Despite signaling a slowdown in the rate of growth, the report exceeded economists’ expectations, showcasing the ongoing resilience of the U.S. economy.
Contributions to GDP Growth
More Evidence of Increased US Growth Potential?
While economic activity decelerated from Q3 to Q4, the latest GDP report offers another data point that suggests the U.S. economy significantly changed during the pandemic. Structural changes like remote work and domestic migration require additional investment, while consumer and corporate borrowers have locked-in mortgages and interest rates for extended periods. It does not necessarily mean the economy will continue to defy higher interest rates, but add it all together, and the ingredients may be in place for a period of above-average growth, even with higher interest rates.
Can the US Economy Continue To Grown Above-Trend?
The Fed's Aggressive Interest Rate Hikes Encourage New Construction
The US housing market continues to exhibit a clear divide. The new construction market is accelerating, with housing starting above the pre-pandemic trend illustrated by the US housing starts chart below. In contrast, the number of existing home sales remains low as homeowners hang onto their existing mortgages and inventory remains tight. The Fed’s tightening created the current housing market dynamic by making selling a home unattractive and taking out a mortgage to buy a new home. The Fed is forcing the new construction market to make up for the housing shortage created by underinvestment following the 2008 financial crisis. This increased home construction contributes to US economic activity, adding to the list of structural changes that can support above-average economic growth. It also potentially increases the chances that the Fed pulls off a soft landing, particularly if the number of housing starts remains elevated.
Housing Starts Remain Above Trend
Existing Home Sales Remain Below Trend
High Nominal Growth Favors Stocks Over Bonds
The US economy grew at a 4.8% nominal pace in Q4. It is a slowdown from recent years when high inflation boosted nominal growth, but it's near the upper boundary of the 2010s decade. If the economy does continue to grow at an above-average nominal pace, it would favor stocks over bonds. Corporate earnings are nominal (i.e., adjusted for inflation) and offer more exposure to stronger nominal growth. In contrast, the interest payments from bonds are locked in for the term of the debt, offering no exposure to stronger economic growth or corporate earnings. It is an obvious statement, but it is worth considering the structural changes to the US economy.
A New Equity Market All-Time Highs and a 4-Year VIX Low
The equity market has not missed a beat transitioning from 2023 to 2024, with the S&P 500 and Dow Jones Industrial Average both making new all-time highs. Like in 2023, a small group of mega-cap growth stocks is propelling the equity market higher. As the equity market makes new all-time highs, the volatility index sits near a 4-year low. The equity market's all-time highs are the more notable development. A case is to be made that investors correctly bid up stocks in anticipation of increased economic growth potential and corporate earnings. However, there is also a case to be made that the market is too optimistic. We lean toward the market being too optimistic in the near term, particularly with expectations for over 1.00% of interest rate cuts this year. However, if the economy continues to grow at an above-average pace, it would be bonds, not equities, that are mispriced.
VIX Trades Near a 4-Year Low
Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.
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