The Economy at a Crossroad

Key Points

• The economy is likely at a crossroads as construction activity and consumer spending have slowed.
• But a softer inflation report a few days ago gave markets something to rally about.
• When diving a bit deeper, we anticipate a consumer who is a bit more selective on where to spend money. The latest retail sales report revealed some key findings.
• The Federal Reserve (Fed) will likely begin cutting rates at its September meeting, but labor markets are key to future Fed decisions and the composition of job gains should give us some additional insight on the health of the job market.

Construction Spending

Recent reports across various sectors reveal an economy at a crossroads.

Single-family housing starts continue to soften as builders put greater attention on multifamily projects. In fact, single-family starts have declined for four consecutive months as builders pull back with the slowing economy. But it’s not all dour. Multifamily projects rebounded after a near-term low in March, although overall building activity is softer than in the last few years.

Multi-family Construction Now Trending Lower

But Increased Supply Will Eventually Dampen Rents

Source: LPL Research, U.S. Census Bureau, 07/17/24

In general, builders are pulling back on single-family projects as they anticipate a broader economic slowdown. Elevated mortgage rates continue to weigh on prospective buyers, but demand for condos seems to be quite resilient. Multifamily projects are supporting the construction industry after a bit of a stall earlier this year. We could expect a modest rebound in single-family projects if the Fed cuts and mortgage rates fall.

Consumers Becoming a Bit More Discerning

June retail sales were roughly unchanged month over month as consumers spent significantly less on gas and autos. Auto sales were down 2.3% on the month as dealers scrambled to make up for a major software blackout, most likely due to targeted cyber attacks.

Consumers are still spending, especially on travel, as the number of individuals going through TSA checkpoints reached a new record.

TSA Throughput Hits A New Record High

Travel Activity Supporting Services Spending

Source: LPL Research, Transportaton Security Administration 07/17/24

Restaurant spending continues to decelerate, a sign that consumers are starting to ease up spending habits, and sales at sporting goods stores and other hobby stores declined for the third time in four months as consumers pull back on discretionary spending.

However, retail activity at warehouse clubs and superstores trudged higher, supporting retailers’ sales goals.

Consumers are pulling back on some items, but they still show signs of resilience. Investors will get a better picture of the consumer in the upcoming personal income and spending release later this month. So far, those consumers who have experienced strong real income growth continue to support the economy with their insatiable appetite to spend.

Private vs Govt Payroll Trends Diverge

Government Payrolls Have Run Hotter in Recent Years

Source: LPL Research, Bureau of Labor Statistics, 07/15/24

Payroll trends are very different when you break out government versus private-sector payroll growth. Private sector payrolls are back on trend, but government payrolls accelerated faster and above pre-pandemic trends. Obviously, private-sector jobs are the ones most impactful for economic growth. The uptick in unemployment claims this year and the slowdown in hirings in recent months suggest the labor market is at a crossroads. That said, although we don’t anticipate apocalyptic signs within the labor market, investors should be wary when the labor market is supported by government payrolls. The downward revisions to the previous two months are consistent with an economic slowdown. Overall, the increase in the unemployment rate, especially for those with at least a bachelor’s degree, suggests a modest cooling of the labor market. We should expect more rhetoric from the Fed about labor market conditions and the importance of keeping policy appropriate for their dual mandate.

Summary

Markets have a lot to digest in the coming months with both political and business uncertainty. Construction activity, consumer spending, and labor markets are at a crossroads as the Fed starts mulling over the timing of rate cuts. Despite some signs of slowing economic growth, primarily at the consumer level, earnings remain impressive. In some sectors like healthcare, labor costs could increase in the near term, putting some pressure on profit margins, though the profit outlook remains favorable overall. Easing inflation pressures point to a potential rate cut from the Fed, likely in September. Technically, the U.S. equity market entered the second half with impressive momentum. The S&P 500 remains in a bull market and above its long-term uptrend, but overbought conditions — especially in technology and semiconductors— and notable divergences in market breadth point to a potential short-term pause or pullback in this rally, along with some rotation into areas of the market that have underperformed this year. After an extended period of low volatility, more market swings are likely, particularly around policy uncertainty related to the upcoming election and heightened geopolitical threats. Seasonality data suggests dips should be bought, as the S&P 500 historically finishes higher in the second half, especially after a strong first half.