What to Make of November’s Dreary US Data

What to make of the US economy? If you follow financial news or look at sentiment measures, you might think things are really, really bad. The latest economic data are mixed, too, with two of this year’s stronger series potentially showing some cracks in November. The consensus view: Things aren’t good and are about to get worse, with many penciling in recession next year. That is possible. But from an investing perspective, a US recession isn’t an automatic market negative, as what matters more for stocks is how expectations align with reality. The popular reaction to the latest November data suggests positive surprise shouldn’t be hard to achieve.

Starting with the “Personal Income and Outlays” report, where the US Bureau of Economic Analysis (BEA) announced real (i.e., inflation-adjusted) personal consumption expenditures (PCE) were flat in November, stalling after October’s 0.5% rise.^[i] Goods spending fell -0.6% m/m while services spending ticked up 0.3%.^[ii] PCE price indexes showed inflation slowed, as headline prices rose 5.5% y/y following October’s 6.1%.^[iii] November was headline PCE’s first month below 6% since January this year, continuing the deceleration since June’s high of 7.0% y/y.^[iv] A big factor: energy prices’ ongoing slowdown. Though PCE energy goods and services prices continued rising at double-digit rates (13.6% y/y in November after October’s 18.4%), they have decelerated considerably from June’s 43.6% clip.^[v] But energy prices aren’t the only ones slowing, as core PCE prices (which exclude energy and food) eased to 4.7% y/y from last month’s 5.0%.^[vi]

Separately, the Census Bureau announced November durable goods orders fell -2.1% m/m, a reversal from October’s 0.7%.^[vii] The widely watched nondefense capital goods orders (excluding aircraft)—also known as “core” capital goods orders and which corresponds to the equipment segment of business investment—rose 0.2% m/m.^[viii] The common reaction to all these data: Inflation may be easing, which is positive, but consumer spending and business demand are softening, which is bad.

November’s figures do imply some weakness. Take durable goods orders, which are typically volatile on a monthly basis. Ever since the US reopened from COVID lockdowns, they have steadily climbed, which is rather unusual. But orders aren’t adjusted for inflation, so higher prices may have been masking the state of demand for a while. Another way to see this: Manufacturing of durable consumer goods—which is inflation-adjusted—has fallen in 5 of the last 7 months, while real consumer spending on durable goods is down in 7 of the past 12.^[ix] If slowing inflation allows weaker demand to be more evident in falling durable goods orders—provided they keep falling from here—that could counterintuitively give investors more clarity and ease the uncertainty inherent in a long run of mixed data.

But that is a big IF, and not just because less-volatile core orders grew while non-defense aircraft orders were the primary drag on headline orders. November’s PCE report put a spotlight on one of the primary drivers of weak durable goods output: autos. Yes, on the surface, the popular takeaway might seem correct—resilient services spending, coupled with falling goods consumption, suggest higher prices are weighing on some discretionary outlays. Most services are essential, after all, which is a big reason consumer spending tends to fluctuate much less during recessions than people presume.

But the main drag on goods spending—in November as well as much of the year—was motor vehicles & parts, which fell -4.3% m/m last month.^[x] Autos have been wacky since COVID lockdowns, which spurred supply shortages first as factories closed, then as semiconductors were scarce. Auto shortages pushed prices far higher—one of 2021’s biggest inflation contributors—and drove up prices for used cars as well. If higher prices are now regulating demand in the face of tight supply, that isn’t necessarily a bad thing. Rather, it is a sign market fundamentals are reasserting themselves and probably aiding a return to normal, in our view. More importantly, it probably also signals heavy industry and consumption aren’t uniformly weak—instead, they may look worse than they are due to one noisy category.

More positively, the price trends we highlighted earlier this month continued in November: goods prices kept slowing while services prices remained at similar levels from the past couple months. To be sure, inflation rates remain elevated. But as supply and demand come into better balance, we think they will likely continue to ease. (Exhibit 1)

Exhibit 1: Ongoing Moderation in PCE Prices

Source: FactSet, as of 12/17/2022. PCE Price Indexes, Headline, Goods, and Services, year-over-year percentage change, December 2020 – November 2022.

Perhaps supporting the view things are less ugly than perceived: The Atlanta Federal Reserve’s GDPNow, a mash up of actual incoming data that constitute GDP and estimates of data to come. The bank now expects Q4 GDP growth to be 3.7% annualized.^[xi] That is higher than December 20’s 2.7% estimate and a rebound from Q3’s -0.6% annualized contraction.^[xii] Why the one-percentage-point jump? Based on latest data, the estimate for real gross private domestic investment flipped from a -0.2% annualized contraction to 3.8% growth. That probably seems weird considering the main data releases that feed into this weren’t fantastic. But it likely means the Atlanta Fed’s modeling was too negative initially—which is sort of a microcosm of how markets work. Even a dreary reality can be a positive surprise if expectations are low enough.

In our view, markets care less about whether the US enters recession and more about how reality aligns with expectations. The general consensus for next year for the US economy appears to be either a “soft landing” (i.e., a slowdown) or a mild recession—so it is unlikely a moderate downturn packs much negative surprise power. If anything, the confirmation of recession may allow people to move on. And if reality turns out a bit better than projected? Even tepid growth can positively surprise and provide some relief.