Quote of the Week
“All you need is love. But a little chocolate now and then doesn’t hurt.”- Charles M. Schulz
For the past few weeks, I have been talking about the economy moving to Quad IV. As a reminder, growth is declining in Quad IV, and inflation is also declining.
While there are a few factors that could change the flavor of the slowdown, such as…
1. The Fed is not tightening as much as markets currently expect.
2. The Russia-Ukraine situation is being resolved without military conflict.
3. Supply chain constraints abating in a meaningful way.
No matter what happens, the underlying math remains the same. The domestic economy faces almost impossible stimulus fueled growth comparables in the second quarter.
In other words, growth and inflation slowdown are imminent, and we can expect a deep Quad IV in the second quarter of 2022, whether you like it or not.
For investors, the time to begin positioning for this reality was in January, when we were starting to pivot to Quad IV. As you may have noticed, we started the pivot by lowering our exposure to equities and increasing our exposure to longer-term bonds. In retrospect, we have started a little too early on the bond side as interest rates have risen slightly, but we were right on the money getting out of the equity markets.
But let’s step back up a bit. The Federal Government spent $$$ hand over fist in pandemic support and stimulus. Mathematically, the Federal Government will drop spending by -$1.3 trillion in 2022, going from $6.85 trillion in 2021 down to $5.55 trillion. This spending drop represents roughly 6% of GDP (Gross Domestic Product).
While overall, GDP should face a 4-5% headwind from the drop in spending, most of the stimulus comparables are in Quarter Two this year, leading to an 8% year over year step-down.
As a huge wave of pandemic benefits were released in March of 2021, the 1-year Base Effect became incredibly challenged, not to mention that the Michigan Consumer Sentiment fell to its lowest level since October of 2011. This drastically missed expectations by hitting 61.7 versus the prior 67.2 and the consensus estimates of 67.
Furthermore, extended unemployment and related benefits began expiring or rolling off in Quarter Four of 2021, meaning people have less cash to spend. Plus, their money is worth less with the last year’s high inflation.
With the consumers’ optimism about the economy at decade lows, benefits rolling off, overly elevated prices, and a massive decrease in federal spending, it’s safe to say demand is about to take an enormous hit. Thus, a deep Quad IV in Quarter Two of 2022 is all but assured.