One prevailing piece of market commentary making the rounds recently is that as persistently high inflation and the Federal Reserve’s rate hiking policies drag on, they will lead the U.S. economy into recession. At the same time, however, we are seeing a number of economic indicators holding up remarkably well. A recent poll by the University of Chicago’s National Opinion Research Center (NORC) highlights this dichotomy, as 80% of respondents claimed they felt the economy was poor, and 85% thought it will get worse, or stay about the same. However, in that very same survey, 62% of respondents were satisfied with their present financial conditions, 62% also said their own financial situation was either getting better or staying the same, and 72% said that the rising cost of living was of no concern, not a problem, or minor in nature.
Lower GDP, but Increased Disposable Income
When last Thursday’s first quarter GDP report came out below consensus expectations at 1.1%, bears pointed out that GDP could fall from here and reiterated their calls for a recession at some point in 2023. While there are certain areas that we are concerned about and watching closely, analyzing beyond the headline shows a more positive picture. For example, Thursday’s report also noted that disposable incomes rose 12.5% from the prior year in Q1, faster than the 8.9% in the December quarter, with the growth chalked up largely to wage gains.
And while inflation remains persistently high, March’s 5% reading marked the lowest annual rate in almost two years. Higher wages are certainly inflationary, but if we are in a period where inflation is staying high partially because workers have 12.5% more money in their pocket to spend and our GDP is still growing, things could be a lot worse.
Record Profit Margins
As far as the impact on stocks, many companies have successfully passed cost increases along to the consumer in the past year. This has not helped reduce inflation either but has also resulted in record profit margins for many firms, even with higher wage costs. As a result, one common theme among consumer goods companies this earnings season has been growth even without increasing transaction volumes, with higher prices and margins more than making up the difference. Procter & Gamble, Home Depot, and many others have reported year-over-year decreases in the overall number of transactions but significant rises in the average ticket per transaction, resulting in net growth. This increase in prices and profitability should and is helping to offset much of the slight declines in transaction volumes consumer-facing firms are seeing as recession fears have emerged and some consumers have anecdotally started to pull back or trade down.
Despite decreased transaction volume for some goods-oriented businesses and a downturn in consumer sentiment, spending actually remains strong. Discretionary spending as represented by JP Morgan’s Discretionary Spending Trends Index has come off its February highs but is still well above pre-pandemic levels, and while some spending has shifted from goods to services, overall spending remains elevated. When restaurant chain Chipotle reported quarterly earnings last week, they announced not only higher prices and margins but also higher volumes, with diners of all income ranges visiting the store more frequently than six months prior.
Resilient Labor Market
One potential reason Americans can afford to eat out more often: the labor market remains remarkably strong, and job openings still far exceed the number of unemployed. Of the layoffs we have seen, many have been concentrated in the technology sector, where 1) workers are generally highly skilled and should be able to find new employment relatively easily, and 2) some organizations had lost cost discipline in prior years, and some efficiency improvements were arguably necessary. As evidenced by Meta and others, the market has generally responded positively to these streamlining efforts and tech has outperformed notably year-to-date, lifting the broader market along with it.
As a result, we do not believe that the extremely bearish sentiment exhibited in some recent surveys can be easily reconciled with the much more mixed market and economic environment we find ourselves in. While risks do remain afoot and we temper our optimism, this is also an environment where risk-reward imbalances, and therefore opportunities, can arise. With over 1,000 stocks reporting earnings this week alone, we will be provided with a huge amount of data on where companies and the larger economy stand and will continue to monitor closely for those opportunities as they arise.
