Is the economy and stocks reaching stall speed?

Stocks took another breather last week, while bonds were little changed. A 0.5% decline in the S&P 500 led the index to 0.8%. The Magnificent 7, which includes Microsoft ( MSFT ), Meta Platforms ( META ), Amazon.com ( AMZN ), Apple ( AAPL ), NVIDIA ( NVDA ), Alphabet ( GOOGL ), and Tesla ( TSLA ), did not perform well last week. 24.9% higher per annum. By comparison, the S&P 500 rose 11.3%.

Recent US economic data has softened at the edges, causing the Atlanta Fed to cut its estimate of second-quarter GDP growth to 2.7%. The softness comes on the back of first-quarter GDP slowing to 1.3%, but the details were better than the headline reading. Additionally, there are signs of all major US consumer price fatigue. Recent trends and retailer earnings indicate that lower-income consumers are being squeezed by the cost of essentials, while higher-income consumers are more price-conscious. The squeeze on consumers was echoed last week, albeit with some respite last week as consumer discretionary stocks have underperformed relative to the S&P 500 since late April.

A softening in economic conditions has not yet permeated earnings estimates. Consensus 2024 and 2025 earnings estimates for the S&P 500 have maintained their upward trend, showing no signs of an impending slowdown.

U.S. 10-year and 2-year Treasury yields are at their year-to-date lows, but have fallen below record highs since late April as economic data softened the edge and friendlier inflation gauges emerged.

Given the performance of more economically sensitive cyclical stocks and less economically tied defensives, there is no signal of a sharp downturn in economic activity ahead. Indeed, despite the relatively poor performance of consumer discretionary stocks mentioned earlier, neither consumer staples nor healthcare companies have seen any consistent outperformance. Also, if markets perceive the possibility of significant economic weakness in the short term, bank stocks will underperform.

April’s reading for monetary levels in the economy still shows no signs of stress. This figure does not explain the stress on low-income households, but shows that cash levels are adequate and higher than before Covid. Evidence points to consumers normalizing to pre-Covid spending and debt levels, rather than heading for an immediate downturn.

In reaction to friendly inflation data and some softer economic growth expectations, markets are now trading at a 60% chance of the Federal Reserve (Fed) easing in September, down from 50% a few days ago. Fed funds futures expect a cut of 25 basis points (0.25%) in 2024.

Initial filings for unemployment benefits have seen an upward trend year-to-date, reflecting a softening in the labor market. Even this increase in initial jobless claims should be put in the background, as the absolute level remains at the low end of the historical range. This week’s monthly jobs report on Friday will be closely watched for further evidence of easing job demand and wage pressures.

While the latest data raised concerns that U.S. consumer spending, vital to economic growth, could be in trouble, other indicators did not confirm fears of an imminent risk. It looks like a continuation of the post-Covid normalization trend coupled with some softness in the labor market. The lack of urgency for defensive sectors such as consumer staples and healthcare shows that this economic slowdown has not seriously increased recession risk in the short term. This easing in economic growth and the labor market could give the Federal Reserve room to start cutting short-term interest rates, thereby increasing the odds of a soft landing.