Last week reinforced one thing most people already knew, and one thing added a new wrinkle to the economic growth story. The inflation story is now well worn, but December’s CPI release added evidence that some of the heightened price pressures are likely to be more persistent. The Atlanta Federal Reserve’s measure of persistent inflation rose to 3.7%. Underlying rent and wage price data indicate inflation is settling above pre-Covid levels, even once supply chain disruptions are in the rearview mirror. The Covid business recovery, which is now spreading to Asia, should temporarily add to price pressures.
The new wrinkle is the drop in consumer spending in December. The US consumer was the driving force behind the robust economic growth expected in the fourth quarter. In the wake of the -1.9% drop in retail sales for the month, the Atlanta Federal Reserve cut its fourth quarter GDP estimate to 5.0% from 6.7%. The result is even worse if you consider that retail sales are reported in nominal terms, so runaway price increases are a tailwind built into this measure. The spike in Omicron business seems to have weighed on the numbers at the margin. The less than one percent drop in bar and restaurant sales provides circumstantial evidence. The massive -8.7% monthly decline in non-store retailers, including online sales, indicates that the main driver is rising holiday shopping this year, with consumers well aware of supply issues. Additionally, the absolute level of retail sales remains well above the pre-Covid trend, so some reversion seems reasonable.
While it is all well and good to know why the consumer went on strike, it is more critical for the economy to know whether it is a more permanent brake on growth. The massive wave of Covid in the US appears to be peaking, so this marginal drag should subside in the coming weeks. The possible wave of construction in Asia could further disrupt supply chains, so it could have some impact here, but to a lesser extent. There remains plenty of reason to be optimistic, with US households overall in excellent shape. Household net worth is at record highs and the percentage of disposable income currently used to support spending is not far off historic lows.
The unemployment rate is extremely low and is expected to fall further in 2022. There is more to this story, however, with the unemployment rate including employed people divided by the labor force. The working population is below the pre-Covid level, so some have decided to stop working. Using data from the payrolls report, the US economy has only recovered 85% of the jobs lost to Covid. This shortfall represents nearly 3.5 million jobs! If the labor force increases, it provides more benefits to economic growth.
Although the small labor force poses a risk to the economy, our measure of current job openings indicates an abundance of employment opportunities. Higher wages and better therapeutic treatments for Covid seem likely to attract more potential workers eventually. Either way, the many jobs available and rising wages are a formula that should continue to support consumer spending.
Despite weak retail sales and Omicron-crimping GDP growth in the fourth quarter, the combination of low unemployment and high inflation still keeps the Federal Reserve on course for a rate hike in March. So far, this environment has led to a rotation from high valuation multiple growth stocks to value stocks. The valuation gap had become historically wide. While the gap has narrowed somewhat with the stock’s recent outperformance, there is room for further compression. Either way, past tightening cycles have seen quality stocks perform well. Having a balance between high-quality growth and value exposure in a portfolio currently makes sense. The fourth quarter earnings season begins to kick off this week with thirty-nine S&P 500s expected to report. So far, bank earnings have been better than expected, but concerns over spending growth have been a drag. A slew of additional banking revenue is coming this week, along with a glimpse of other industries.