Economy slows more than expected

Gross Domestic Product (GDP) for Q1 2024 came in way lighter than expectations of 2.2% at 1.6%.   This is a significant slowdown from the 3.4% rate in Q4 of last year. Under the surface, however, were some important highlights. Personal and disposable income both grew at a faster rate than the prior quarter, while the savings rate declined. On a “current dollar” basis, which is not inflation-adjusted, the economy grew at 4.8% versus 5.1% in the prior quarter. The big difference was inflation was significantly higher than the prior quarter at 3.4%. Since GDP is a real number, which means it's adjusted for inflation, the headline number came in low.

• Lots of commentators have pointed to this report as impending stagflation
• Stagflation is when we experience a recession, and inflation is too high
• This is not what this report indicated
• The consumer is almost 70% of the economy and seems to continue to be strong
• However, inflation was higher than expected, which is what really hurt the real number
• While stocks initially sold-off and bond yields surged, we think it was more associated with the inflation read through than the actual GDP reading
• This, to us, continues to be the main issue to focus on

Inflation and bond yields rise

Relatedly, the Fed’s preferred measure of inflation, PCE, came in higher than expected at 2.8% for core. This was higher than the prior month’s reading of 2.5%. The trend is now clearly upwards, which doesn't bode well for rate cuts this year. The market is now pricing in only 2 cuts by year end, down from 6-7 expected at the beginning of the year. What is more concerning is long-term bond yields have continued to rise, with the 10-yr bond trading through 4.7% for the first time since late last year.

• The most concerning part of the report was the trend is clearly up
• The 3-month annualized PCE is now 4.4%, which is up from 2% a quarter ago
• The probability of rate cuts continues to decline
• Long-end bond yields, however are the more concerning trend
• Long-dated debt (including mortgages) is priced off the long end of the interest rate curve
• The recent spike in long yields has corresponded to a similar spike in mortgage rates
• This makes housing less affordable, and in the absence of being able to buy homes, people will continue to rent, putting upward pressure on prices
• Just as concerning is the interest cost of the US government
• The US treasury finances the federal government through a mix of short and long-term debt
• The higher the long end of the bond market trades, the more expensive it is to issue new debt
• With interest costs already out of control, this exacerbates our fiscal situation

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The capex cycle is in full swing

Earnings continued this week, with 30% of the S&P 500 companies reporting.  Four of the MAG 7: MSFT, META, GOOGL, and TSLA reported this week.  A clear trend from META, GOOGL, and MSFT is that capex is growing significantly.  META guided to $30-40bn of capex this year. MSFT had $14bn of capex in the last quarter, this is more than an entire year of capex just 5 yrs ago. GOOGL reported $12bn, double the prior quarter.  

• Most of this spend is on GPUs and other infrastructure that these companies need to continue to develop their generative AI models
• This is obviously bullish for companies like NVDA
• However, this also has downstream implications on energy companies, utilities, and industrials as the infrastructure needs to be built and powered
• This is marginally negative for consulting businesses and certain SAAS companies as the new technology allows for some of these functions to be built in-house
• While the bears point to no data around the ROIC of this spend, the trend remains firmly in place for now

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