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Iron Capital Insights

  • Iron Capital Insights
  • February 2, 2022
  • Chuck Osborne

What is Real?

What is the real rate of growth? GDP growth rebounded in the 4th quarter of 2021. After slowing to 2.3 percent in the third quarter, the initial reading for 4th quarter is 6.9 percent. Does that mean we are back to the solid growth of earlier in 2021? It doesn’t feel that way.

While 6.9 percent seems like healthy growth, we must factor in that inflation is 7 percent. Also, when you average the 2.3 percent and 6.9 percent, the second half grew at 4.6 percent versus more than 6 for the first half. Is it any wonder that people do not feel as if the economy is doing well?

Factor into that 6.9 percent growth the fact that more than 4 percent of that was inventory-building, and the picture becomes a little clearer.  What this tells us is that 3rd quarter was not really as bad as reported. However, most of the activity last quarter was simply companies getting their supply chains sorted, so it isn’t as good as it sounds. The 4.6 percent average is probably a good way of looking at it, realizing that there is a clear pattern of slowing growth.

On top of this, payroll provider ADP reported that its clients reduced their payroll by 300,000 jobs last month. The expectation was for a growth of 200,000 jobs. While they are among the largest in the industry, ADP is only one payroll provider, and their report does not always foretell the official government employment situation report. Still, this is not a good data point for the economy.

In contrast, corporate earnings have been largely positive, which should not be unexpected in an inflationary environment. It won’t be universal, but most companies will benefit, on paper anyway, from inflation. It makes revenues seems higher and can be a boost to nominal profits, if the expenses are paid before the revenues come. Of course, that isn’t real because next month’s expenses will be higher, but they aren’t in the reports.

Inflation often provides a small boost to demand as well. Those who can afford things have a little more urgency to make that purchase today, because if they wait then it will cost more in the future.  All that does is move consumption from next month into this month, but as mentioned, “earlier next month” isn’t in a report. By the time they have to report on next month prices will be higher still, and we do this whole convoluted inflation dance all over again.

This puts the market in a quandary. Earnings will be strong, at least in nominal terms, while real growth continues to slow. Last week the market seemed focused on the poor state of the economy; this week they are focused on earnings. Next week? Who knows?

In the long term company earnings should win out, but in the short haul, markets are likely to be choppy. Careful selection is likely to be very important, remembering that we are investing in companies, not trading pieces of paper. (I know there is no more paper, but it still sounds better.) Many companies will benefit from this environment, and ultimately their stock price will reflect that reality.

Warm regards,

Chuck Osborne, CFA
Managing Director