Bottom Line: Economic growth is stronger than expected and considerably better than feared. That is an important support for a rebound in market laggards. Small caps outperformed large yesterday. Value and risk-on factors, segments that have most lagged the firming economic backdrop, were yesterday’s best performers.
Relevant News: The GDP and December PCE were generally favorable. 4Q23 GDP beat expectations yesterday, coming in at +3.3% (ar) vs estimates of 2%. Core PCE came in right in line with target m/m and the y/y pace, at 2.9%, now has a 2-handle. Nominal wages and salaries growth has remained steady near-5% for much of the year, and spending growth continues to look healthy.
Things to Watch [consensus]: (1/30) JOLTs [8700K] (1/31) ECI [1.0% QoQ] & FOMC, (2/2) Payroll w/ revisions & AHE [180k, 0.3% MoM], (2/9) CPI Revisions, (2/13) CPI [3.4% YoY].
Economics: Post GDP and PCE Update
22V’s economist longer-term take on the GDP release is that recession risk is declining. In his view the economy keeps beating expectations while inflation has fallen and the rate-sensitive/cyclical sectors have suffered serious drags. The overall strength of the consumer, reluctance of firms to lay off workers, robust nominal topline growth, and the asynchronized nature of many of the hits to economic activity means that the long-expected recession has not yet materialized.
On PCE, core inflation has been around the target since June, with a 6-month annualized pace of 1.9%. in 22V’s economists view, the threshold for rate cuts has become somewhat lower. Core inflation stands at 2.3% over 9 months but remains high at 2.9% over 12 months.
For example, Food away from home, an indicator reflecting labor cost impact and discretionary spending, continues to exceed pre-COVID trends, signaling inflationary pressures. But nominal wages have held steady, similar to 2018-19 levels, suggesting compatibility with stable inflation. Real personal spending appears solid, with improvements in November and December, although seasonal factors post-COVID may affect monthly patterns.
Portfolio Strategy: Economic Growth Survey Results
The investors we polled this week are getting more optimistic about the economy too. Only 5% of respondents have raised their recession expectations relative to their baseline from before the December Fed meeting. Nearly 70% think real GDP growth will be in-line or beat expectations this year too. Our view is a turn in sentiment will help contribute to an internal rotation (along with data), bringing laggards more in-line with the economic Growth regime, like we saw yesterday.
Beyond catchups, lower recession risk will continue to benefit Cyclicals relative to Defensives longer-term. Within Cyclicals, Early Cyclicals (Tech, Comm Svcs, Discretionary) that are less exposed to Size and Momentum, and Deep Cyclicals stand to outperform. After a Value catchup, our favorite factor play is GARP. The Fed won’t let economic growth runaway, so some exposure to Growth along with Value makes sense. FYI, our formulation of GARP outperformed Growth ex-GARP and Value ex-GARP yesterday.
Washington Policy: Considering How a Trump Victory Would Affect Markets
Considering how a re-elected President Trump would affect markets likely is only partly informed by his record in office and idiosyncratic statements. 22V’s Washinton policy team starts with a look at what can easily be erased of President Biden’s record. The balance of power in Congress is another determinative factor in imagining how a change at 1600 Pennsylvania Avenue might influence trading or investing narratives. Without unified government and a governing majority in the Senate, broad policy changes outside executive orders will be limited. With those thoughts in mind, we offer our first effort at a 2024 Trump basket for your consideration and possible denigration.
