Naysayers and the Q2 2024 U.S. GDP Numbers
Underestimating the U.S. economy’s fundamental strength was a theme in 2023. At the outset of the year, nearly every polled economist predicted the U.S. would enter a recession as the Federal Reserve raised interest rates, with a stated goal of lifting the unemployment rate to tame inflation. Instead, the economy grew 3.1% for the year and added nearly 3 million new jobs.
Fast forward to 2024, and the U.S. economy still has its doubters. It is common to see the argument that the U.S. consumer is tapped out—pandemic savings are gone, people are increasingly frustrated by nominally higher prices, and households are weighed down by rising debt loads and high interest rates.1
Yet the economy keeps chugging along.
In the second quarter, the Commerce Department reported that the U.S. economy expanded at an annual rate of 2.8%, to a level of $22.9 trillion. That’s significantly more than the 2.1% rate economists had expected, and it also marks a significant acceleration from the 1.4% annual GDP growth rate posted in Q1 2024.
From an investment perspective, the elements of GDP that matter most to stocks—private sector components and consumer spending, in my view—were solid nearly across the board.
Breaking these down, we saw businesses investing in commercial construction, equipment, and software at a stout 5.2% annualized rate, up from 4.4% in the last reporting period. Capital expenditures (capex) were driven by an 11.6% increase in spending on equipment and a nearly 5% increase in software/intellectual property investment, which in my view demonstrates that corporations are going on offense—not what you’d expect to see in a tenuous economic environment.
Capex Jumped in Q2 2024, as Businesses Invested in More Equipment and Software
U.S. consumers also had a good quarter, continuing a trend that has lasted years now.
Sometime in 2023, we started hearing about pandemic savings running dry, and pockets of weakness appearing in the labor market. More recently, I’ve seen warnings of rising delinquencies and consumers feeling squeezed by higher prices and the effects of higher borrowing costs. While much of this is true, it simply hasn’t translated into a consequential pullback in spending.
To be fair, solid consumer spending data in Q2 owes partially to a weak first quarter, when spending on goods fell -2.3% annualized. The base effect made a rebound in spending easily attainable, and consumers delivered. But if consumers are feeling pinched by the effects of high inflation and borrowing costs, there’s some positive news as it relates to the outlook from here: inflation continues to moderate, and I expect borrowing costs to move lower—not higher—in the next year.
To add, U.S. consumers continue to benefit from a steady labor market where wages (blue line in the chart) are rising at a faster-annualized pace than inflation (red line, CPI). These rising real wages give U.S. consumers more spending power in the face of inflation, not less.
Wages are Rising at a Faster Annual Pace than Inflation
Putting it all together, the odds of a “soft economic landing” keep going up, as economic growth continues apace while inflation continues to moderate. From an investment standpoint, that’s good news for stocks, in my view. But it could be especially positive for small caps.
With Fed funds currently between 5.25% and 5.5% and the latest inflation reading (according to the Fed’s preferred measure, the PCE price index) at 2.5%, monetary policy is quite restrictive. An outlook that interest rates will be lower in the future than they are today is a constructive setup for small-cap stocks.
Valuations should help this setup. Because large-cap growth stocks have had an impressive run especially relative to small-cap stocks, there’s a valuation gap that makes small-cap stocks look inexpensive on a relative basis. As of the end of Q2 2024, for instance, small-cap value stocks were trading at 96.7% of their 20-year average P/E, while large-cap growth stocks were trading at 149.2% of 20-year P/E averages. If rate cuts do come and the U.S. economy continues to surprise to the upside, small-caps could easily lead to the next phase of the bull market.
Bottom Line for Investors
I do not want to paint the picture that the U.S. economy is in perfect shape with few risks to growth. But I also think it is not accurate to frame the economy in doubtful terms or to say it is performing poorly, as many do. The second quarter GDP data—along with the past years’ worth of better-than-expected economic data—proves that the U.S. economy is still expanding solidly, despite higher interest rates. Stocks’ strong performance underscores as much.
Disclosure
2 BEA. July 25, 2024. https://www.bea.gov/data/gdp/gross-domestic-product
3 Fred Economic Data.
4 Fred Economic Data. July 5, 2024. https://fred.stlouisfed.org/series/CES0500000003#
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