Economic Update: April 24, 2023

Growth

4Q22 real GDP showed the economy grew by a 2.6% annualized rate and 0.9% for the calendar year, even with the economy contracting for two consecutive quarters in the first half. While the overall print looked solid, the underlying details still point to a weakening economy. More than half of the GDP gain came from an increase in inventory accumulation (a trend that will inevitably be reversed), real consumer spending was softer than expected and residential investment plunged further. Looking ahead, boosts in real personal income, pent-up demand for autos and a very tight labor market should keep growth afloat, but very modest, in the year ahead.

Jobs

The March Jobs report highlighted a labor market that remains tight but is losing momentum. Nonfarm payroll employment rose by 236K, a sharp deceleration compared to last month, while the unemployment rate slipped below consensus to 3.5%. Average hourly earnings grew by 0.3% m/m and 4.2% y/y, signaling easing inflationary pressures. Overall, this report confirms that the economy, while gradually losing momentum, was not in a recession in the first quarter. However, the question remains whether or not the labor market is cooling as fast as the Fed would like.

Profits

The 1Q23 earnings season has kicked off, with 84 companies having reported (18.4% of market cap). Our current estimate for 1Q23 operating earnings per share is $49.66, representing a y/y gain of 0.6% and a q/q decline of 1.4%. This estimate for tepid y/y growth is primarily due to an alleviation of macro headwinds being offset by slowing demand. So far, 67% of companies have beaten earnings expectations, while 55% have beaten revenue expectations. Notably, margin contraction has been the largest detractor in earnings while revenue has grown modestly.

Inflation

The March CPI report was cooler than expected with headline CPI rising by 0.1% m/m and 5.0% y/y, marking the smallest year-over-year increase since May 2021, while core CPI rose by 0.4% m/m and 5.6% y/y. Moderating food and energy prices weighed on the headline print with food at home falling by 0.3% m/m and energy declining by 3.5% m/m. Shelter inflation more than offset these declines and remained the largest contributor. However, it slowed compared to last month. Overall, this report suggests that headline CPI should fall below 4.0% y/y by June, and strengthens the argument for a Fed pause at the upcoming FOMC meeting in May.

Rates

At its March meeting, the FOMC hiked rates by 0.25% to a range of 4.75%-5.00%. The statement language and press conference were somewhat dovish, acknowledging the potential implications of banking turmoil on the economic outlook but also the need for further progress on inflation. The Fed notably downshifted the phrase “ongoing increases in the target range…” to “some additional policy firming may be appropriate,” signaling a near end to tightening. The median rate expectation for year-end was unchanged at 5.1%. Updates to the Fed’s economic projections reflected a more dovish picture of slower growth, lower unemployment and slightly higher inflation.

Risks

  • Banking sector turmoil could result in tighter lending standards, posing a drag on economic growth.
  • An overly aggressive Fed could push the economy into recession.
  • Markets may remain depressed and volatile until investors receive clarity on the pathway for inflation and the Fed.

Investment Themes

  • After 2022’s sell-off, fixed income now offers higher yield and more protection against a market correction or economic downturn.
  • Solid profit growth and reasonable valuations will be crucial in determining equity winners in a higher rate environment.
  • Long-term growth prospects, a falling dollar and wide valuation discounts support international equities.

This weekly update provides a snapshot of changes in the economy and markets and their implications for investors.

Originally Posted April 24, 2023 – Economic Update

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