The Wall of Worry is Growing Again
A string of recent U.S. economic data has many investors worried.
Earlier in April, the U.S. Bureau of Labor Statistics reported that the Consumer Price Index (CPI) measure of inflation rose 3.5% year-over-year in March, which marked a fairly substantial increase from February’s 3.2% print. Hotter-than-expected inflation is not what investors, consumers, or the Fed want.
To be fair, the Federal Reserve prefers the PCE price index measure of inflation, which gives significantly less weight to shelter costs. But that measure of inflation also came in higher-than-expected in March, with a 2.7% year-over-year increase marking a step-up from February’s 2.5% print.
A major dialing-back of rate cut expectations ensued. Investors started the year hopeful that the Federal Reserve was going to lower the benchmark fed funds rate multiple times, with about 150 basis points of total cuts anticipated for 2024. By last week, however, the market was only anticipating about 35 basis points of cuts, with none expected this summer or fall.
While inflation, and by extension, rate cuts, seemingly moved in the wrong direction in Q1 2024, the U.S. economy also slowed. The Bureau of Economic Analysis (BEA) reported that the U.S. economy expanded just 1.6% in Q1, which is the slowest pace in nearly two years and was notably below most economists’ expectations.
Put rising inflation and slowing economic growth together, and it’s easy to leap to “stagflation” being muttered in financial media and amongst investors. What’s more, investors are also aware that crude oil prices have been rising, geopolitical tensions in the Middle East and Russia/Ukraine have risen in temperature, and the U.S. presidential election looms large.
Measures of U.S. consumer sentiment, like the University of Michigan survey below, have been improving in recent months. But it’s important to note that sentiment is improving from very low levels in 2022, when many Americans felt as bad about the economy as they did during the depths of the 2008 Global Financial Crisis.
Consumer Sentiment is Still Below What We’d Expect During a Sustained Expansion
‘Worrisome’ economic data, combined with sour sentiment, signals to me that the wall of worry remains firmly intact. And I see that as a good thing for stocks. The reason I take a constructive view here is that jobs, consumer spending, and corporate earnings remain solidly positive.
Though the BEA’s “advance” estimate of Q1 2024 GDP growth showed a deceleration from 2023, we know from the report that inventories and trade provided a notable drag. If we look at growth through the lens of consumer spending and business investment – known as Final Sales to Provide Domestic Purchasers – we find the U.S. economy posting a strong 3.1% pace of growth in Q1. Real consumer spending grew at a brisk 0.5% month-over-month pace in March.
Consumer Spending and Business Investment Show a Still-Healthy Economy
Then there’s the U.S. corporate earnings picture, where Zacks sees an environment of steady improvement and resilience, with the earnings growth pace modestly accelerating and estimates for the coming periods starting to increase. Total earnings for the 139 S&P 500 members that have reported Q1 results (as I write) are up +4.6% from the same period last year on +3.4% higher revenues, with 78.4% beating EPS estimates and 59.7% beating revenue estimates. These are good numbers.
Looking at Q1 as a whole, the total S&P 500 earnings are now expected to be up +4.4% from the same period last year on +3.9% higher revenues, which follows the +6.8% earnings growth on +3.9% higher revenues in 2023 Q4. In my view, this data combined with consumer spending and jobs numbers points to a positive growth outlook, even as the wall of worry grows.
Bottom Line for Investors
There are times in the market when investors get too greedy, and times when investors get too fearful. I sense that the latter sentiment is more pervasive today, which arguably makes it an attractive time to buy. Growth decelerated in Q1, but it’s still solid. And inflation ticked slightly higher in February and March, but is a far cry from being unanchored or rising uncontrollably. Our base case that interest rates have peaked in this cycle remains intact.
These are all constructive views on the outlook for the U.S. economy, even as investors seem to grow more pessimistic about what the year ahead holds. In my opinion, that’s bullish.
Disclosure
2 Fred Economic Data. April 25, 2025. https://fred.stlouisfed.org/series/LB0000031Q020SBEA
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