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US Economy Showing Strong Cyclical Momentum

Apr 29, 2021

Executive Summary

  • Preliminary Q1 GDP data was reported and showed strong cyclical momentum in the US economy.
  • The housing sector and durable goods consumption sector continue to show outperformance, a positive cyclical signal.
  • It is highly uncommon to see an economic downturn while housing and big-ticket consumption are rising.
  • The secular economic conditions are still pressing downward, highlighted by a persistently weak measure of velocity, but there are no signs of downside cyclical pressure in the months ahead.

US Economy Showing Strong Cyclical Momentum 

(To expand images, you can "right-click" and select "open link in new tab.")

Preliminary data on Q1 GDP showed real economic growth rising at a 6.4% annualized pace, up from a prior reading of 4.3% in Q4. 

Real economic growth was boosted by consumption and investment, strong cyclical signals. Government spending was also a large contributing factor to the overall 6.4% annualized figure. 

The GDP data series is an extremely comprehensive report. Therefore, the report should be analyzed for the long-term (secular) trends and the short-term (cyclical) trends. 

Worsening secular conditions plague the US economy, namely, faltering population growth and high levels of debt. Moreover, the overindebtedness condition is manifesting itself in weaker productivity, revealed by the velocity of money. As a result, the continued increases in the broad money supply are becoming less effective at generating incremental GDP growth. 

While those secular conditions are not changing anytime soon, the economy also experiences cyclical trends that occur within a multi-decade secular trend. 

This current business cycle is, without question, a unique cycle. Forced business closures and impeding the consumption of services caused a rapid rise in the consumption of durable goods, above and beyond what normal supply can handle. 

When analyzing the cyclical trends in the economy, there are several "stress points" to check. These stress points are the most cyclical or vulnerable areas of the economy, subject to bigger booms and busts. Specifically, the housing/construction sector, the durable goods consumption sector, and the manufacturing/industrial sector are the main stress points in a developed economy. These areas are all subject to changes in interest rates and drive the large swings in overall economic growth. 

Nominal GDP per capita has regained the pre-COVID peak. 

Nominal GDP per Capita:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

If economic growth is carried higher by the economy's most cyclical sectors like housing and durable goods, then the economy has cyclical momentum and should continue to perform well in the months ahead. Only when the cyclical areas of the economy start to show weakness is an economy most vulnerable to a recession or major downturn. 

The broadest measure of the housing/construction sector in the GDP report is residential fixed investment. Residential fixed investment rose as a percentage of total GDP in Q1. 

As the chart shows, the housing sector generally starts to decline as a percentage of total GDP in advance of major economic downturns. 

Residential Fixed Investment as a % of Total GDP:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

Durable goods consumption has exploded as a percentage of GDP. Now, this level of durable goods consumption as a percentage of GDP will likely reverse back to the pre-COVID levels. When it does, the economy will experience serious downside pressure, but as long as the ratio is rising, the economy will have strong momentum. 

Durable Goods Consumption as a % of Total GDP:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

If we aggregate these two very cyclical sectors, residential fixed investment, and durable goods consumption, we see strong growth relative to total GDP. 

It would be highly uncommon from a historical standpoint to see a major economic downturn without these two cyclical sectors softening relative to total GDP first. As a result, the US economy maintains strong cyclical momentum into the summer. 

Residential Fixed Investment + Durable Goods Consumption As A % of GDP:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

While the economy clearly shows progress, the velocity of money declined in Q1 despite the strong momentum, which reminds us that the secular economic trends of worsening demographics and heavier debt burden are still a headwind. 

The velocity of money was expected to increase as the economy reopened. The economy was certainly more open in Q1 2021 than in Q2 2020, yet velocity did not increase. 

Velocity of Money:

Source: FRED | To Expand, Right-Click > "Open Link In New Tab"

Persistently low velocity tells us that the cyclical upturn in the economy will be short-lived. 

As investors, we are tasked with balancing the long-term (secular) trends with the short-term (cyclical) trends. 

At times like today, the economy can have cyclical momentum within a secular downturn. 

It is important to increase exposure to cyclical and pro-growth assets like stocks and commodities during cyclical upturns in the economy from an asset allocation perspective. 

Investors must keep a close eye on the cyclical trends in the economy because cyclical trends always give way to secular trends. In the near future, cyclical economic momentum will turn down and once again align with the downward secular trends. At this point, an asset allocation pivot would be necessary. 

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If you are looking for regular updates on the short-term cyclical trends in the economy, as well as asset class preferences, consider subscribing to our monthly Cyclical Leading Indicators report. 

One time per month, for an extremely low price of only $12.99/mo, we outline the most important cyclical leading indicators of the economy and review asset class preferences in the context of equities, fixed income, precious metals, and commodities. 

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We also publish a quarterly presentation covering both long-term (secular) economic trends as well as short-term (cyclical) economic trends and the resulting impact on asset prices such as equities, fixed income, gold, and more. 

For more information on the EPB Quarterly Presentation & Outlook product, click here.

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