"It's tough to make predictions, especially about the future." – Yogi Berra
Economic forecasters have had a tough year, and the latest employment report didn't do much to improve their batting average. The U.S. created 353,000 new jobs in January, blowing away the expectation. On top of that, the Bureau of Labor Statistics revised its previous December estimate upwards by 117,000 to 333,000 new jobs for a total of 686,000 over the past two months. There are now over 6 million more private sector jobs than at the previous pre-pandemic peak in 2019. Caramba.
Defying the broadest consensus in memory just a year ago, the U.S. economy is ripping and shows few signs of stalling any time soon. Entering 2023, the median forecast for real GDP growth was around 0.3% for the year, including a couple of negative quarters comprising at least a mild recession. All the signs were there.
To retard the sharp spike in inflation, the Federal Reserve was raising interest rates at the steepest pace since 1981, boosting the benchmark fed funds rate from 0.25% to 5.5% and running off some of its massive bond portfolio. These restrictive measures were intended to tame price pressures by cooling the rate of economic activity, including employment growth. Their own prediction included an unemployment rate approaching 4.5% by the end of 2023.
Economists' confidence in forecasting a recession was buoyed by the most reliable indicator of impending slowdown, an inversion of the yield curve. That means interest rates on longer-dated treasury bonds were temporarily lower than short term rates, an abnormal condition that has always preceded historical recessions. In fact, this inversion was the steepest and longest in memory, and remains in effect today.
Talk of a so-called soft landing began to surface during the third quarter, as unemployment refused to appear and the economy gained momentum with real GDP surging at an annual pace of 4.9% in Q3. Then in January, the Bureau of Economic Analysis tallied fourth quarter growth an annual rate of 3.3%, double the expectations. For the full year, the economy gained 2.5% versus the puny predictions of 0.3% and retains a head of steam chugging into 2024.
Consumers are gaining confidence according to the latest survey, and they continue to open their wallets thanks in part to the astoundingly robust job picture that has only improved over the past couple of months. Spending by individuals and households makes up more than two thirds of all U.S. economic activity; as goes the consumer, so goes the economy. The latest University of Michigan survey found consumer sentiment, an important driver of spending, has surged by 29% over the past two months. The recent jobs report also showed wages continued to increase in 2023, with real disposable (after tax) personal income rising 4.2%. Households made up some of the ground lost to price increases in 2022, and they are spending it.
Other useful indicators are also constructive. The Institute for Supply Management index of services activity rose to 53.4 in January suggesting strong consumer demand for travel, dining and other services. A number above 50 suggests the services sector is expanding.
Meanwhile, corporate profits have recovered from the pandemic slump and are clobbering analysts' estimates so far during the current season of quarterly reporting. So far 75% of S&P 500 companies have beaten expectations, led by a nearly 20% increase in profits among information technology firms and strong gains in the energy sector. Higher interest rates have barely dented profits, and in fact private investment, a component of GDP, has increased since the Fed started hiking rates. Anticipation of a recovery in corporate earnings fueled a strong performance in U.S. equities, with the S&P 500 gaining 24% last year and hitting a new all-time high this month.
Without doubt, the picture has been significantly brighter than most analysts expected, but there are some signs of potential slowing ahead as 2024 unfolds. The number of job openings has been declining, and pandemic-induced labor shortages have slowly receded, while "quits" or workers voluntarily leaving their job has also subsided, suggesting wage increases could slow over the next few quarters. Most of the pandemic stimulus money has been spent, personal savings rates have slumped, and credit card debt has surged far above its 2019 peak, raising questions about the consumer's ability to continue their spending spree. Delinquencies on car loans and credit cards has risen notably, especially among younger borrowers. And of course, global geopolitical developments and domestic political turmoil could derail the growth train.
Investors have reason to remain optimistic but not expect the same explosive gains in 2024. Part of the equity rally has been fueled by unrealistic expectations for an early easing of monetary policy, including a rate cut in March. The latest Fed meeting and announcement last week should put that notion to rest. Inflation has slowed impressively and is trending in the right direction but has not yet reached the central bank's target of 2%. Chair Jerome Powell threw cold water on the timing of rate cuts until the Fed sees more decisive evidence that the battle is won.
Yogi Berra's dictum offers a useful reminder. Last year confounded most experts, and the consensus has now evolved from recession through soft landing to no landing for 2024. Experience suggests humility in forecasting, but at least for now the year ahead looks pretty good.
Christopher A. Hopkins, a chartered financial analyst, is a co-founder of Apogee Wealth Partners.