Economic data from the first three months of the year was recently released, and the numbers weren’t encouraging. On the surface, the numbers are somewhat alarming because the readings in the first quarter of the year didn’t include the impact of the tariffs. But that’s not the whole story… there’s more encouraging data beneath the surface.
Gross Domestic Product (GDP) measures the total value of goods and services produced in a country and is a helpful gauge to measure economic activity. For years, economists used this measure to define a recession, which is generally viewed as two consecutive quarters of negative GDP growth. As you can see from the chart above, the economy had been on a pretty steady growth trajectory before the first quarter. So what led to the negative number this quarter?
The chart above shows a more detailed breakdown of economic activity. Consumer spending and corporate investment were rather strong in the first three months of the year, which is encouraging to see. The largest detractor was the imbalance in exports and imports. When US companies produce and export goods overseas, our GDP increases. When we import goods from overseas, it subtracts from our GDP (because we are bringing in goods and services from overseas rather than consuming US-based products). The difference between exports and imports was the main contributing factor to the contraction in GDP.
In fact, the imbalance between exports and imports last quarter was the most dramatic in recorded history (going back to the end of World War II). While this is the exact opposite impact that the current tariffs are trying to address, it shouldn’t come as a shock and isn’t necessarily a bad thing.
In the President’s inauguration address on January 20th, he referenced “Liberation Day” as the day that bilateral tariffs would be imposed. From that day forward, US consumers had a signal that tariffs were coming, causing many consumers to “pull forward” purchases before the tariffs took effect. Thus, imports surged in the first quarter, leading to a negative impact on GDP. In our eyes, this makes the quarter’s decline in GDP less concerning than past instances of shrinking GDP. We would be much more concerned if consumer spending or corporate investment were the culprit for the negative GDP outcome.
Next quarter’s GDP report will likely show a dramatically different story as imports are likely to grind to a halt from the increased cost of the tariffs. Who knows what will happen with the other inputs, but the reduction of imports should help reduce the odds of another negative GDP print.
While I wouldn’t put a lot of weight on this negative GDP outcome, it is worth noting that the economy is showing signs of a slowdown. The private sector added only 62,000 jobs in March, about half of analysts' estimates, existing home sales declined by almost 6% in March, and earnings revisions are coming down (all of which is a bad sign). Also, the preferred inflation gauge of the Federal Reserve moved higher in March. This metric, referred to as the Core Personal Consumption Expenditure Price Index (Core PCE for short), is an inflation gauge that excludes the cost of food and energy.
All of this leaves the Federal Reserve in a bit of a conundrum. A slower economy would typically be an environment in which the Federal Reserve would look to reduce interest rates. However, a higher inflation reading generally signals the opposite. Couple the conflicting data with the pressure from the President to reduce interest rates, and the Federal Reserve finds itself in a difficult spot.
What does all of this mean for investors? We, too, find ourselves at a bit of a crossroads. Does the economy slow to the point that it tips into recession? Does inflation ramp up from the increased cost of the tariffs? Will the Feds cut rates? Will it even matter if they do at this point? Safe to say, we appear to be at an economic inflection point.
Stocks have rebounded from the initial lows due to a temporary reprieve from the high tariff rates, but it’s tough to see a path in which the stock market re-takes new highs based on the current uncertainty and signs of a pending slowdown. We remain cautious, however, we do see opportunities for investors with a longer time horizon and are consistently looking (and waiting) for bargains to emerge.
Stay tuned…
Any opinions are those of Brady Raanes and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.
Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.
The investments mentioned may not be suitable for all investors. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.
Past performance may not be indicative of future results. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.