Is the U.S. headed for a recession?

[dan_s]

Mitch Zacks says no or at least not because of one quarter of GDP contraction.

The U.S. Economy Contracted in Q1 – Is a Recession Ahead?
The news caught many investors and even economists off guard – U.S. gross domestic product (GDP) contracted at a -1.4% annual rate in Q1 2022, which also marked a drastic turn from the 6.9% annual growth rate registered in Q4 2021. The U.S. economy was supposed to be firmly in growth mode, with Zacks projecting ~3% GDP growth for the full-year 2022.1

So, what happened? And should investors be worried?

There were many factors that pulled the U.S. GDP number lower in Q1 2022, and I would argue that investors should not be too worried about any of them. There were three main detractors from the GDP headline figure:

Trade Deficit – Imports are subtracted from GDP figures while exports are added. Imports often make their way into other parts of GDP, most notably in consumer spending, which is the reason they detract from GDP. But as I have written before, investors should not get too fixated on trade deficits as a measure of an economy’s overall health. What matters more is total trade, which gives a better indication if more goods and dollars are trading hands overall.

To that point, total trade was up solidly in Q1. The imports of goods soared 11.5% to $294.6 billion, while the exports of goods also rose 7.2% to $169.3 billion. The fact that imports rose at a much faster clip than exports is a negative for GDP calculations, but does not necessarily signal trouble in the economy. In fact, trade has subtracted from U.S. GDP growth for the last six quarters, which has been a strong period overall for growth.

Slow Inventory Investment – One of the main drivers of Q4 2021’s robust 6.9% GDP figure was inventory investment by businesses. Many companies – fearing additional supply chain snags in the new year and anticipating higher demand – stocked up on products. The inventory buildup in Q4 was enough to add over 5% to headline growth, a pretty massive contribution. It makes some sense, then, that in Q1 2022 companies would not need to keep up that same pace of inventory investment, which ultimately meant that inventory investment subtracted -0.84% from GDP. That’s an over 6% difference from one quarter to the next, which is not very typical and I believe should normalize going forward.

Falling U.S. Government Spending - Finally, government spending fell as the stimulus measures tied to the pandemic have largely run their course. Government spending fell at a -2.7% annualized pace, which in Q1 2022 meant subtracting 0.48% from the headline GDP figure. This part of the GDP equation did not come as a surprise to anyone watching closely – the fading effect of pandemic stimulus spending is widely known.

In my view, none of the above three factors are recessionary at these levels, and a closer look at the most meaningful components of GDP– consumer spending and private sector demand – show very solid strength.

In the first quarter, consumer spending grew at a 2.7% annual rate, and spending accelerated from Q4 2021. It is worth mentioning again that GDP grew 6.9% in Q4 2021, meaning that consumer spending accelerated from already strong levels.

We also note consumers shifted spending materially in Q1 from goods to services, which is a trend that should help ease inflationary pressures in the coming months. A prime example is rising spending on travel and hospitality – U.S. hotel occupancy was at 65.8% in the last week of April, which is up from 49.6% at the end of January. The Transportation Security Administration (TSA) also reported that 2.1 million travelers passed through security in late April, up from 1.4 million in January.

Private sector demand showed strengths in other categories as well, with business investing rising at a solid clip. Investments in areas like software, equipment, and research grew 9.2%, contributing to the 3.7% annualized increase in overall private demand. These data readouts are not the stuff of recessions. Far from it, in my view.

Bottom Line for Investors

Here is some final data to consider: the Conference Board’s Leading Economic Index (LEI), which has historically been a reliable harbinger of economic conditions that lie ahead. While imports, government spending, and inventory investment were all detracting from GDP, the LEI continued to show a U.S. economy that was firmly in expansion mode. LEI increased by 0.3% in March, which followed a 0.6% increase in February and also marks a 1.9% increase over the past six months.3

A negative GDP reading for one quarter may make the U.S. economy look weak, but that does not mean it is weak.