There were three significant economic events since my last column: the GDP report, the Fed meeting, and the unemployment report.
The Q1 real GDP growth rate (3.2% annualized) surprised nearly everyone to the upside. And, of course, Wall Street characterized the headline number as proof that the “soft patch” had passed. Never mind the details. Of the 3.2% growth, nearly .7 percentage points came from inventory growth. This was likely stockpiling ahead of the tariff threats. Another 1 percentage point of the 3.2% growth came from net exports. Exports rose by $23 billion, a number not likely to be repeated given the shape of the economies outside the U.S. Worse, there was a fall in imports to the tune of -$33 billion. This is an indication of weakness in the U.S. consumer. Finally, government added another .4 percentage points to the growth. Taking these three items out of the growth leaves a paltry 1.1% real underlying growth rate, still positive, but showing the economy is decelerating toward stall speed.
In addition, the GDP price deflator is going the wrong way for the Fed. Observe the trend: Q1/19: +0.9%, Q4/18: +1.7%, Q3/18: +1.8%, Q2/18: +3.0%. After this GDP report, markets were convinced that the Fed would have to cut interest rates because their 2% inflation goal was rapidly receding.
Enter the Fed
The Fed held its normal meeting on April 30th and May 1st. There is half an hour between the Fed’s official statement and Powell’s press conference. The statement acknowledged, for the first time, that core inflation is below the Fed’s 2% target. From the statement alone and that admission, market participants concluded that the Fed’s next move would be a rate cut, perhaps soon. And, rates immediately moved lower across the yield curve. But, then, in the press conference, Powell said he thought that the low inflation data was “transitory” meaning rates would revert toward the Fed’s 2% target without further Fed action. That dashed the initial market interpretation, and interest rates reversed course with yields along the curve ending the day higher than they began. Perhaps this was a faux pas, similar to his utterings back in November that caused the December market meltdown.
The headline number in the Establishment Survey (ES) looked quite strong at 263k. What wasn’t widely reported was that the workweek contracted 0.3% in April, and, has fallen in three of the past four months. In terms of income, the shorter workweek is equivalent to a loss of about -375k jobs.
But, what about the fall in the unemployment rate to 3.6%? Isn’t that the quintessential sign of great economy? The “other” employment report, the Household Survey (HS), collected concurrently with the ES, is the source of the unemployment rate. In that survey, there was a decline of -103k jobs in April. This was the fourth month in a row that the two surveys have been at 180-degree odds in their measurement of net new jobs. The fall in the unemployment rate from 3.8% to 3.6% was heralded by Wall Street as further proof that the economy remains on “solid” footings. The media failed to mention that the only reason the unemployment rate fell was because the labor force shrank by -490k, which followed a -224k drop in March and a -770k drop since last December. This implies discouraged job seekers. If not for the drop in the labor force, the unemployment rate would be somewhere north of 4%.
What is Driving Stock Prices?
Over the past 12 months, S&P 500 companies spent more money on stock buy-backs than they did on capex. That is, they opted to use their cash to reduce their share count rather than to spend it on new projects and organically expand. No wonder growth is so anemic! The stock market doesn’t appear to be paying any attention to the underlying fundamental economy. If it were, it wouldn’t be anywhere near today’s record highs. Instead, it is banking on the hope that the Fed, and the rest of the world’s central banks, have its back.
Looked at from a different perspective, a weak economy, or at least a slow growth one, guarantees low interest rates. That, in turn, allows publicly traded companies a venue for low cost borrowings which are used to buy-back shares. Without changing any operations, hiring or firing, with a single phone call to an investment banker, earnings per share are increased (earnings remain the same but there are fewer shares).
Conclusion – The Fed as Deus Ex Machina
The stock market has simply stopped being a barometer of the economy. The truth is that the equity prices are rising due to scarce supply, and not due to great economic fundamentals. The economic data scream of a high potential for recession, or, at best, stall speed economic growth. Because Wall Street still talks like the equity market is driven by the underlying economy (i.e., the “narrative” that the economy is “solid”), it could be that a recognition of stall speed growth will put a “scare” into the market. But, then, again, by that time, Jay Powell may have walked back from his utterance that low inflation is “transitory,” and the Fed may, once again, play the role of the deus ex machina, when, just in time, it steps in to save the markets.
Robert Barone, Ph.D.
Robert Barone, Ph.D. is a Georgetown educated economist. Robert’s career includes his having served as a Professor of Finance, a community bank CEO and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently an Investment Advisor at Four Star Wealth Advisors (775 284-7778). He is also a Director of CSAA Insurance Company, a Director of the Northern California/Nevada/Utah AAA auto club, and a co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (FFIU).
Statistics and other information have been compiled from various sources. The facts and information are believed to be accurate and credible, but there is no guarantee as to the complete accuracy of this information.