The initial Q2 GDP estimate of 2.8% came as a surprise, exceeding the consensus view of 2.0%. However, the equity markets responded tepidly, with selling pressure prevailing by the end of the day. Unwanted inventory accumulation and government spending were significant factors contributing to the growth, along with a drawdown in the savings rate. Consumer spending rose, but after-tax personal income only saw a modest increase, leading to record high credit card balances and rising delinquencies. Without the government spending growth, inventory accumulation, and savings rate drawdown, GDP growth would have been closer to 0.5%.
Following the GDP announcement, the Personal Consumption Expenditure Index (PCE) for June showed a slight increase, leading to lower year-over-year inflation rates. This news boosted the equity markets, with the DJIA ending the week slightly positive and the Russell 2000 posting a significant weekly gain. The shift in sentiment towards small cap stocks, with expectations of Fed rate reductions, has driven the rally in smaller companies. The performance of the top stocks, deemed the “Magnificent 7,” has been on the decline, with prices falling despite a market rally on Friday.
Incoming data in various sectors paints a grim picture of economic softness. The Chicago Fed’s National Activity Index, the Philadelphia Fed’s Non-Manufacturing Index, and The Conference Board’s Leading Economic Indicators all showed negative readings, indicating a probable recession. Existing and New Home Sales are down, with unsold inventory increasing significantly. Inflation appears to be on the decline, with falling prices of raw materials and potential deflation on the horizon.
Corporate performance in the second quarter has been lackluster, with several companies reporting misses in earnings and revenues, citing economic softness as a key factor. The Fed’s restrictive policies have had a significant impact on various sectors, including a struggling commercial real estate market. With monetary policy still considered restrictive even after potential rate cuts, concerns about the quality of loan portfolios, especially in the CRE space, are rising.
Despite the higher than expected GDP growth, various indicators point towards economic softness ahead. Investor sentiment has shifted towards small cap stocks, driven by expectations of rate cuts and relief for highly leveraged businesses. Housing and CRE markets continue to struggle, and inflation is expected to continue falling. Overall, the economic outlook remains uncertain, with a potential recession looming on the horizon.
