The Markets - May 1, 2023
Get real!
Despite more than a year of aggressive Federal Reserve rate increases, the United States economy is still growing, albeit more slowly. U.S. gross domestic product (GDP) – the value of all goods and services produced in the U.S. economy – grew by 5.1 percent over the first quarter.1
You may have read or heard that real GDP increased by 1.1 percent over the first quarter.2 That is also true. In economics, “real” means the value of something after inflation (inflation is the rate at which prices are increasing). For example:
- A real return on an investment is the return after inflation has been subtracted.3 So, if an investment earns 7 percent and inflation is 4 percent, the real return in 3 percent.
- Real growth in personal income is income after changes in the cost of goods and services are considered.3 For example, if personal income increases by 5 percent, from $50,000 to $52,500, and inflation is 4 percent, the real increase in income is 1 percent.
- In the first quarter, real GDP was lower than GDP because real GDP reflects price changes – and prices have been moving higher.
Last week, the Personal Consumption Expenditures (PCE) Index, which is one of the Federal Reserve’s preferred measures of price increases, showed that inflation generally continued to trend lower.4
- Headline inflation was 4.2 percent in March, year-over-year, down from February when it was 5.1 percent.4
- Core inflation, which excludes food and energy prices, was up 4.6 percent, year-over-year, down slightly from February when it was 4.7 percent. However, month-over-month, core inflation remained unchanged.4
Inflation and Fed rate hikes have had less impact on company earnings than analysts anticipated. To date, 53 percent of companies in the Standard & Poor’s 500 Index have reported results for the first quarter and almost 8 of 10 have reported that earnings per share was higher than expected. Overall, S&P 500 earnings are expected to dip in the first quarter before increasing later in 2023, reported John Butters of FactSet.5
Last week, major U.S. stock indices finished the week higher, according to Nicholas Jasinski of Barron’s.6 Yields on U.S. Treasury notes and bonds moved lower last week.7
WHY IS INFLATION SO STUBBORN? Inflation is proving to be almost as stubborn as an angry two-year-old determined to eat popsicles for breakfast. Many have pointed to the tight labor market as the reason prices continue to rise. While labor costs are an important factor, there are other issues at play, too.
When the national news reports on a shock – the war in Ukraine affecting food supplies, the pandemic affecting supply chains, bird flu producing an egg shortage, or a dairy farm explosion affecting the price of milk – companies may take the opportunity to raise prices because customers are less likely to complain about the increase, reported Tracy Alloway and Joe Weisenthal of Bloomberg.8
Companies in an industry, such as soft drink makers or chicken wing restaurants, may raise prices in tandem, giving consumers little choice but to pay the higher price. When the shock is resolved and wholesale prices move lower, companies often don’t lower retail prices. Instead, they simply keep prices high.8
Isabella Weber and Evan Wasner at UMass Amherst listened to earnings calls, compiled data on companies, and reviewed literature about corporate price-setting. Their research paper reported that overlapping emergencies in recent years have allowed companies to increase prices and profits. They dubbed the phenomenon “sellers’ inflation”.9 They wrote:
“Sellers’ inflation is not possible in a perfectly competitive economy, but in a highly concentrated economy in which large firms are price makers, it is a real possibility – as we are witnessing again today.”9
Sellers’ inflation may be another reason inflation has been sticky.
In theory, a recession and falling consumer demand should cause companies to lower prices. However, as Weber and Wasner pointed out, recessions have the potential to hurt smaller businesses, if they have difficulty finding funding, and increase the power of larger ones.9
Weekly Focus – Think About It
“Character is like a tree and reputation like a shadow. The shadow is what we think of it; the tree is the real thing.”10
—Abraham Lincoln, former U.S. President