A Slowing Economy: The Evidence

A Tough Week for Equity Markets

Equity markets faced significant challenges this week, with the bulk of the losses occurring on Friday, February 21, as investors scrambled to respond to a barrage of disappointing economic data. The realization that the economy is slowing down seems to have finally sunk in for many traders. Key indicators such as consumer confidence, retail sales, and housing market activity all painted a gloomy picture, while inflation expectations unexpectedly ticked up, further complicating the outlook.

The University of Michigan’s monthly consumer confidence survey revealed a sharp decline of nearly 5%, signaling that Americans are growing more pessimistic about the economy. This sentiment was mirrored in retail sales, which fell by 0.9% in January, with online sales plummeting 1.9%—the worst performance since July 2021. The housing market also showed signs of weakness, with existing home sales dropping 4.9% in January, while new home sales remained stuck in a sideways trend. These developments, combined with a higher-than-expected inflation outlook, sent shockwaves through the markets, leaving investors increasingly concerned about the direction of the economy.

The equity market’s performance over the past four weeks reflects this growing unease. As shown in the table below, markets have now declined in three of the last four weeks, with only the Russell 2000 struggling to stay near its recent highs. While most indices remain close to their peaks, the overall mood has shifted decidedly bearish, particularly after a string of underwhelming economic reports. The “Magnificent 7” tech stocks, which have been a driving force behind the market’s recent gains, also took a hit, with six of the seven stocks ending the week in the red. Apple was the sole exception, managing to eke out a gain, while Meta, which had been a standout performer year-to-date, gave back over 7% of its gains. Tesla, meanwhile, continued its downward trajectory, solidifying its position as the biggest loser among these tech giants so far this year.

The Economy is Slowing Down

The U.S. economy is undeniably in a deceleration phase, and this slowdown is not a new development—it’s just one that has only recently garnered widespread recognition. In the fourth quarter of 2024, GDP growth slowed to a 2.3% annualized rate, down from 3.1% in the third quarter and 3.0% in the second quarter. This deceleration is being felt across multiple sectors, with retail sales, housing activity, and industrial production all showing signs of weakness.

One of the clearest indicators of the slowdown is the retail sales data. January saw a 0.9% decline in total retail sales, with no segment of the market immune to the downturn. Online sales, which typically benefit from bad weather, fell by 1.9%, their worst showing since July 2021. Spending on furniture, appliances, and autos also declined, while apparel sales—a reliable indicator of consumer confidence—dropped 1.2% from December levels. The weakness in retail sales is not just a one-off; it appears to reflect a broader trend, with small businesses reporting slower sales and even retail giant Walmart projecting a modest 3%-4% sales growth for the upcoming year. Add to this the significant layoffs of federal workers, which will likely weigh on upcoming employment reports, and the picture looks increasingly bleak.

The housing market is another area where the slowdown is evident. Existing home sales fell 4.9% in January compared to December, although they were still 2.0% higher than the same time last year. The median home price rose 4.8% year-over-year but fell 1.7% from December, marking the seventh consecutive month of declining or flat prices. New home sales, meanwhile, remain stuck in a sideways trend, with high interest rates continuing to weigh on demand. Regional sales data painted a similarly gloomy picture, with the West, Northeast, and South all seeing declines, while the Midwest was the only region to show no change.

Inflation and Consumer Confidence

While the economy is slowing, inflation remains a persistent concern. The Consumer Price Index (CPI) continues to be heavily influenced by rents, which account for 35% of the index. However, the data used to calculate rental rates is lagged by nearly a year, meaning the current surge in vacancy rates and the flood of new apartment units hitting the market have yet to fully impact the figures. As a result, the recent run-up in rental rates appears to be in the rearview mirror, and the stage is set for a potential period of deflation by the third quarter.

Credit card debt has also reached record levels, and delinquency rates are beginning to rise—not just for credit cards, but also in the mortgage market. These developments are likely to weigh on consumer confidence, which has already started to wane. The University of Michigan’s consumer confidence survey highlighted a sharp decline of nearly 5%, a worrying sign for an economy that is heavily reliant on consumer spending. With inflation remaining stubbornly high and consumer confidence crumbling, the Federal Reserve’s “higher for longer” stance on interest rates seems unlikely to change anytime soon.

Employment and the Labor Market

The Bureau of Labor Statistics’ Quarterly Census of Employment and Wages (QCEW) has thrown a wrench into the labor market narrative. While the monthly Non-Farm Payroll (NFP) reports have consistently shown strong job growth, the QCEW data tells a different story. Through September of 2024, the QCEW showed that the economy created just 1.3 million jobs, compared to the 1.98 million net new jobs reported by the NFP data—a discrepancy of 680,000 jobs. This amounts to an overstatement of 75,000 jobs per month, casting doubt on the perceived strength of the labor market.

This gap between the two datasets is significant and raises questions about the accuracy of the monthly employment figures. While the labor market has undeniably been a bright spot in recent years, the QCEW data suggests that the reality may be less rosy than previously thought. With significant layoffs of federal workers on the horizon, the upcoming NFP reports are likely to reflect even more weakness, further confirming the notion that the labor market is not as robust as it appeared.

Housing Market Weakness and Industrial Production

The housing market continues to struggle, with both existing and new home sales showing signs of weakness. Existing home sales fell 4.9% in January compared to December, although they were still 2.0% higher than the same time last year. The median home price rose 4.8% year-over-year but fell 1.7% from December, marking the seventh consecutive month of declining or flat prices. New home sales, meanwhile, remain stuck in a sideways trend, with high interest rates continuing to weigh on demand.

On a year-over-year basis, existing home sales rose 2%, but new listings were up 17%, putting downward pressure on prices. This dynamic is unlikely to change in the near term, as high interest rates continue to deter potential buyers. The regional sales data painted a similarly gloomy picture, with the West, Northeast, and South all seeing declines, while the Midwest was the only region to show no change.

Industrial production, which has been flat for the past couple of years, finally showed some life in January, but it remains to be seen whether this uptick will be sustained. While industrial production is not as dominant a factor in the economy as it was 30 years ago, it still plays a significant role in overall economic activity. The rebound in January could be a hopeful sign, but it’s too early to declare a full-blown recovery.

Leading Indicators and Interest Rates

The Conference Board’s Leading Economic Indicators (LEI) fell again in January, declining by 0.3%, and have now dropped 0.9% over the past six months. The LEI has been signaling an economic slowdown for three years, but its predictions have yet to materialize. This has led many economists and forecasters to question the credibility of the index. The outsized federal budget deficits in recent years may have artificially propped up the economy, masking the underlying weakness. Now that the Trump administration and Congress have taken a more fiscally conservative approach, the LEI may regain some of its predictive power.

As for interest rates, the markets are in a holding pattern, waiting for the Federal Reserve to signal its next move. The Fed has maintained its “higher for longer” stance, and until inflation shows signs of cooling, rates are likely to remain elevated. While some analysts believe the Fed could cut rates later in the year, this scenario is far from certain. With the economy slowing and inflation still stubbornly high, the path forward for interest rates remains uncertain.

Final Thoughts

The financial markets, particularly the equity market, appear to have finally caught on to the fact that the economy is slowing down. The late-week sell-off, triggered in part by Walmart’s disappointing retail sales forecast, is a clear indication that investors are growing increasingly nervous. The data backing up this nervousness is compelling: retail sales fell nearly 1% in January, the housing market is weakening, and employment data is now showing signs of strain.

The most prominent indicator of the economic slowdown is the decline in retail sales, which fell 0.9% in January. This drop was not just a blip; it reflects a broader trend of weakening consumer activity. The recent employment data from the Bureau of Labor Statistics has also poured cold water on the notion of a strong labor market. The QCEW data revealed a 680,000-job discrepancy compared to the Non-Farm Payroll figures, suggesting that the labor market is not as resilient as previously thought.

Housing is another area of concern, with existing home sales continuing to lag and new home sales stuck in a rut. Industrial production, which had been flat for years, showed a glimmer of hope in January, but it’s too early to know if this is a turning point. The Leading Economic Indicators, which have been signaling a slowdown for years, have lost some credibility, but they may regain relevance now that fiscal policy has become more conservative.

Interest rates remain a key wildcard in this economy. While the Fed has indicated that rates will stay high for the foreseeable future, the slowing economy and rising delinquency rates may eventually force a reevaluation. For now, markets don’t see a rate cut until late in the year, but some analysts believe it could happen sooner. One thing is certain: the economy is slowing, and higher interest rates are only exacerbating the pain for housing and private sector businesses.

In conclusion, the combination of slowing economic growth, weakening consumer confidence, and persistent inflation is creating a challenging environment for financial markets. While there are still pockets of strength, the overall picture is increasingly bearish. Investors will need to stay vigilant as the economy navigates this uncertain terrain.