Strong GDP Growth Propels Investor Sentiment

This morning’s GDP release shows the economy grew 2.9% in the final quarter of 2022, beating the consensus estimate of 2.8% and helping to soften concerns about a potential recession. The strong growth, however, is creating additional headwinds for curtailing inflation that could cause the Federal Reserve (the Fed) to double-down on its hawkish stance against persistent price increases. The robust number is not supporting this year’s strong rotation into growth stocks by equity investors who are anticipating that interest rates won’t climb as high as previously thought.

In another confusing day in markets, the S&P 500 was up roughly 1% near the open but has reversed to unchanged, giving back those gains. Bond investors are weary of this strong of a GDP number and its potential to generate another leg higher in inflation. Bonds are generally up 3 to 5 basis points across the curve driven by the long-end. The dollar is rallying as well alongside crude oil, up .4% and 1.5% in late morning trading. The recent loosening of financial conditions (14 consecutive weeks), is in fact pushing inflation higher, with the Cleveland Fed inflation nowcast model showing a whopping 0.6% rise in the headline CPI and 0.5% in core for January, a far cry from the Fed’s 2 percent annual target.

Looking under the hood, today’s GDP number was buoyed by inventories and net exports, making the headline a little less appealing. Services and goods spending contributed to positive consumption, while business investment and government spending also underpinned gains. Residential investment, however, continues to be a drag on growth as higher interest rates and high valuations constrain the real estate sector against the backdrop of front-loaded expansion during the pandemic.

The laid off workers may not be transitioning to jobs as lucrative as their previous ones, with country club  rivaling office buildings sporting state of the art gymnasiums, recreation areas, theatres, cafeterias, steam rooms and hot tubs, but they’re finding jobs nonetheless. “Another day another dollar.”

In another surprising development, the Labor Department reported this morning that initial jobless claims declined by 6,000 to a seasonally adjusted 186,000, substantially below the pre-pandemic level in 2019, which averaged 220,000 a week. The labor shortage continues, with layoff headlines failing to make their way into the official data. Workers are finding jobs elsewhere, against the backdrop of an economy featuring a plethora of job openings. The laid off workers may not be transitioning to jobs as lucrative as their previous ones, with country club rivaling office buildings sporting state of the art gymnasiums, recreation areas, theatres, cafeterias, steam rooms and hot tubs, but they’re finding jobs nonetheless. “Another day another dollar.”

Broadly speaking, earnings reports this week have painted a bearish outlook for economic growth and corporate financial results, although aviation has been an exception.

Microsoft, with its strong exposure to the business marketplace, is one example. Total revenue for the company’s fiscal second-quarter ended December 31 decelerated to 2% year over year (y/y), the slowest growth since 2016. Its $52.75 billion in revenue missed the $52.94 billion expected by a consensus of analysts. Its new business weakened in December and the company expects the trend to continue in the coming months and its revenue guidance of $50.5 billion to $51.5 billion for the current quarter fell short of the analyst consensus expectations of $52 billion. The company is laying off 10,000 employees.

Tesla, which is an indicator of the health of U.S. consumers because the company’s cars are big ticket items, grew its fourth quarter revenues to $24.32 billion up from $17.72 billion in the fourth quarter of 2021 and above the consensus expectation of $24.16 billion. In a bearish indicator, however, Tesla has responded to higher interest rates, which make cars less affordable to consumers who finance purchases, and weakening consumer spending by slashing prices for its models by as much as $20,000 in the U.S. and U.K.

Aviation is faring better as consumers increase their traveling after sheltering in place during COVID-19 restrictions, which is placing new demands on airlines to increase their fleets. Boeing anticipates increasing the number of airliners it delivers in 2023 and its guidance calls for the company to generate from $3 billion to $5 billion in free cash flow this year. It generated $3.1 billion in free cash flow in 2022. In related news, American Airlines this morning said that its fourth quarter revenues increased nearly 17% from the fourth quarter of 2019, which was just prior to COVID-19 restrictions shutting down air travel. It was able to increase revenues with higher fares. It expects its capacity usage to increase as much as 10% year-over year in the first quarter. United Airlines also beat analysts’ expectations and its guidance calls for a 20% first quarter y/y increase in flying.

At this point in the economic cycle, GDP is a double-edge sword. With Powell on the mound, rocking the Federal Reserve uniform, he may use recent accelerating data as a justification to surprise the market with a 50 basis point hike. Investors seem indifferent of the potential that he’ll announce a longer-than-anticipated period of higher interest rates or additional rate increases to contain inflation. Stronger-than-expected GDP can make it more likely that the Fed will remain hawkish, thereby leading to a reduction in speculative activity. The flip side, however, is that negative GDP or recession, will crimp future corporate revenues and earnings, which will weaken investor sentiment for equities overall.

Visit Traders’ Academy to Learn More about Unemployment Claims, Gross Domestic Product and Other Economic Indicators.