Welcome to the latest installment of the “Navigating Earnings Season” blog series. In this series, I dive into the world of earnings reports from major companies, spanning giants like J.P. Morgan and Pepsi, as well as niche players in various sectors. As the earnings season unfolds, these corporate outlooks offer real-world insights that often contrast sharply with the uncertainty emanating from the Federal Open Market Committee (FOMC).
With his Jackson Hole speech, Federal Reserve Chair Jerome Powell all but promised rate cuts were coming. That’s cool. But it is why that matters. Is the economy struggling under tight monetary policy? Not really. Are asset markets beginning to crack and show signs of stress, causing angst among policy makers? Not really. Is inflation decelerating and the labor market cooling? Yes.
These “initial conditions” matter. The outlook for the economy and markets would be different if something were breaking. Breaking is bad. Cooling is an entirely different story.
Kansas City Fed Labor Market Conditions Index
Source: Kansas City Fed, as of 7/1/24.
Conveniently, the Kansas City Fed compiles major labor market indicators into a single, useful data series. The labor market has undoubtedly softened from its post-COVID peak. It should be noted how quickly the labor market went from Great Recession weakness to near-all-time tightness. The labor market is cooling, but it is not collapsing. Those two things can coexist.
Inflation Two Ways
Source: Bureau of Labor Statistics, as of 7/1/24.
The inflation story is not dissimilar. Inflation pressures have not magically collapsed, but—as Chair Powell made clear in his speech—it is all about confidence that the trend will continue. Confidence is different from a declaration of mission accomplished. Part of the confidence may stem from a dramatic return to normal on the goods side of inflation (commodities less food and energy). Goods inflation surged, then fell back to normal levels of deflation. Services tend to be stickier, but that has begun to fall as well.
Growth Has Been Good
Source: Bureau of Economic Analysis, as of June 2024.
Growth has held up well. There have been bumps along the way, but growth has not fallen off a cliff. GDP is useful, but final sales is a good check. Final sales strips the volatility of inventories and net exports from the calculation, and the private version goes a step further and eliminates the changes in government spending as well. Intriguingly, the quality of composition of growth over the past 18 months has been high, as evidenced by the steady growth in final sales.
All of that is to say, the rate cuts are coming without panic. The economy—as a whole—is fine. There have been headwinds. Manufacturing and housing have been rather dismal in the wake of interest rate increases. But those are also set to benefit from the shift to a less restrictive stance from the FOMC. The headwinds of yesterday may well become the tailwinds of tomorrow. We will see.
Source: Federal Reserve Economic Data (FRED), as of March 2024. Excluding inventory valuation adjustments and capital
consumption adjustments allows for a better view of profits across industries. See the Bureau of Economic Analysis website for
more details.
There are questions no one wants to ask. What if corporate America navigated this cycle well and the historically elevated multiples reflect management competence instead of investor euphoria? What if rate cuts are not stoking a bubble—they are extending a nominal GDP and wage mini-boom? What if investors should be worried—not by budget deficits or the fall of the dollar but 1) that the U.S. economy has plowed through every hurdle; 2) the promised recession never materialized; and 3) COVID-19 resulted in better supply chains and a more diversified economy?
When looking to the future, there are always reasons to be fearful. Maybe it’s not that bad. Maybe it’s even good. Maybe it’s great. The future should be embraced, not feared. There are plenty of headwinds for the U.S. economy. But those may well be the tailwinds of tomorrow.
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