US Q1 GDP: Better Than Pundits Said

US Q1 2024 GDP came out Thursday, and here is the take you have probably seen: Growth slowed more than expected while inflation accelerated, showing sticky prices are affecting output and making Fed rate cuts a distant dream. Markets seemed disappointed, with the S&P 500 falling over -1.5% in the morning before clawing back as the day wore on to finish down less than -0.5%.^[i] Short-term volatility is always a wildcard, unpredictable, but we doubt stocks’ renewed inflation jitters last long. And when they get over that, we suspect markets will see this was actually a pretty ok GDP report once you dig in.

First, we would be remiss not to mention the Bureau of Economic Analysis has long had some troubles getting Q1’s seasonal adjustments correct, and they have been transparent about seasonal math’s pulling Q1 growth rates down for many years. COVID lockdowns and reopenings exacerbated the problem. This weird period is still in the seasonal adjustment math, so it is possible—not certain, but possible—that some of Q1’s slowdown from 3.4% annualized growth in Q4 to 1.6% is partly a figment of seasonal skew.^[ii]

But let us take the report at face value anyway and look under the hood. Yes, GDP slowed, and yes, the Personal Consumption Expenditures (PCE) price index accelerated to a 3.4% annualized rate for the quarter. But it is too simplistic to interpret this as faster inflation knocking output. The headline growth rate isn’t always telling since GDP encompasses more than the private sector—and the private sector is what stocks care about most. GDP includes it, but it also treats all government spending as a positive, ignores that imports represent domestic demand, and always counts inventory builds and depletions as plusses and minuses, respectively, even though they are open to interpretation.

So when we assess GDP, we think the best place to start is the private sector components least tainted by such skew: consumer spending, business investment and residential real estate. Combined, these segments grew 2.6% annualized in Q1, right in line with Q3 and Q4. Doesn’t look to us like stubborn inflation is whacking private sector activity.

Exhibit 1: GDP and Its Private Sector Components

Source: FactSet, as of 4/25/2024. GDP, Personal Consumption Expenditures, Nonresidential Fixed Investment and Residential Investment, Q1 2022 – Q1 2024.

Rather, the detraction came from the less meaningful parts of the equation. Inventory depletion detracted -0.4 percentage point, which lays the ground for future restocking—as Purchasing Managers’ Indexes are already pointing to.^[iii] Imports detracted a full percentage point because they grew 7.2% annualized, implying healthy domestic demand.^[iv] And government spending’s contribution slowed to a measly 0.2 percentage point as Federal spending flatlined while state and local spending crawled, which is ancillary to corporate earnings.^[v]

The private sector components did have a couple of weak spots, but these didn’t reveal anything new to stocks. Consumer spending on durable goods fell -1.2% annualized, but this stemmed primarily from auto sales’ fourth straight drop.^[vi] Between high car prices, high auto loan rates and the well-documented electric vehicle demand drop, weakness here is quite well known. Similarly, within business investment, spending on structures fell -0.1% annualized. But this follows four straight quarters of double-digit growth and amounts to a slight breather. Meanwhile, investment in equipment rose 2.1% annualized, snapping two straight declines, while investment in intellectual property products (e.g., software and R&D) accelerated to 5.4% annualized.^[vii] Businesses, it seems, are turning up the dial and switching to offense after two years of cuts to mitigate the effects of a recession that never came.

That last bit, not what prices and GDP did in Q1, is likely what matters for stocks from here. Stocks look about 3 – 30 months out, pricing in expected corporate earnings over that stretch. As Corporate America ramps up, deploying more capital and launching more projects, it creates more opportunities for earnings growth—opportunities forward-looking stocks should eat up with glee.