We got our second update for Q1 GDP this week, and real GDP was revised slightly higher to -0.2%, although spending was revised lower and corporate profits declined. Net exports were by far the biggest drag on growth in Q1, but this could very well reverse over the next few quarters, now that a lot of the front-running of tariffs is most likely behind us.
Nominal GDP came in at $29.98 trillion, for an annualized return of 3.4%, and 4.7% higher than Q1 2024.
GDP price index
(inflation) rose to 3.7% annualized, the highest reading since Q4 2022.
Real GDP is calculated by subtracting nominal GDP from the price index, which gets us to an economy that shrank by -0.2% annualized in Q1.
Real GDP is now $23.5 trillion and 2.1% higher than a year ago.
Breaking down the components of Q1 GDP, we can see that the import surge was by far the biggest drag on growth. But consumer spending (roughly 70% of GDP) was revised down from 1.2% to 0.8%.
Real consumer spending grew at a 1.2% annualized rate in Q1, down from 4.0% in Q4 and below the historical average of 2.33% (orange line). It was the slowest pace of spending growth since Q2 2023. And most of the spending gains came from buying autos in March, in anticipation of tariffs causing price increases. Without that late splurge, real spending was headed for a negative growth quarter, only seen during the 2008 GFC and 2020 covid shutdown.
Corporate profits fell 2.9% in Q1, as tariffs and consumer sentiment hit companies bottom lines. It’s the worst quarter since COVID.
Summary: It’s easy to write off Q1 as being distorted by the tariffs (net exports), but it hides the fact that spending was weak. While imports should moderate significantly in proceeding quarters, its not as certain that spending will rebound.
Recent developments has poked some holes in my bear thesis. My original thesis was the combination of slower growth and fiscal spending cuts (the sugar high was over), along with very high valuations, was going to be too much for the stock market to handle in the near term.
But since then, the fiscal spending cuts appear to be much lower than was advertised. This could change (and will likely have to change at some point, as deficit projections aren’t sustainable), but it looks like the disruption isn’t as bad as initial estimates. Remember, Federal & state spending had contributed roughly 20-25% to GDP over the last few years. It’s very unlikely we’ll see that level of fiscal spending again, but the worst-case scenarios appear to be off the table.
The tariff uncertainties remain, but so much has been exempted at this point, and companies are already finding loopholes, that the net effects may not be that disruptive after all. But this could change.
Stocks remain expensive, though. That part of the thesis hasn’t changed. The S&P 500 earnings yield is now 4.56% compared to a 4.42% treasury yield. Leaving the equity risk premium, a paltry 0.14%. It’s lowest since prior to the 2008 GFC.
But this probably only matters if we get a significant economic slowdown. And with AI productivity gains, the odds of a real slowdown are lower then they were after liberation day.
I’m still not excited about stocks at these price levels. But I’m not fighting it either.