Capital Markets Update #11

We received a truckload of data this week, it may be helpful to give the data some context.  Some of the below is dense, but we believe necessary to dissect the information we have at hand. We have to really understand the subject before we can use the data to our benefit.

Real GDP grew at a 1.4% annualized rate in the 4th quarter, down from 4.4% annualized growth in Q3 2025 (BEA data).  2025 total GDP growth of 2.2% YoY was down from 2.8% YoY growth in 2024.   Inter-quarter volatility shows the extent to which the US economy tilted under the pressure of a series of massive and strange forces.  For instance, US GDP dropped 0.6% QoQ annualized in Q1 2025 as tons of gold and other commodities were imported into the US following the announcement of the Administration’s tariff policy, demolishing the trade deficit and, thereby, tanking GDP.  We then saw incredibly strong quarterly growth in Q2 and Q3 2025 of 3.8% and 4.4% annualized, respectively.  Finally, we capped the year with a weak 1.4% annualized GDP growth in Q4 2025 as the ridiculous government shutdown wiped a minimum of 1.2% from the Q4 GDP reading. At face value, 16.6% QoQ annualized drop in government spending was to blame.  But, the shutdown impact was much more pernicious than a simple drop government expenditures – just look at retail sales.  Advanced retail sales growth dropped from excellent 4.7% YoY growth in August 2025 to 3.0% YoY growth in October (the first month of the shutdown) to 2.1% by December (all FRED data).  In other words, after quite the strong year year-to-date, retail sales just nosedived, both linearly and on a sequential monthly basis once the shutdown talk reached a fever pitch in September in expectation of lower government spending and 23 million federal employees likely not getting paid.  Tying retail sales back to GDP data  - if you were to take a simple average of trailing 3-year quarterly consumer expenditures (that’s 12 different quarterly datapoints, for the uninitiated), you would have gotten another ~75bps back in total GDP growth. For reference, consumer expenditures dropped in from 3.5% annualized in Q3 2025 to 2.4% annualized in Q4 2025.   If you read the research at the time, pundits blamed the slowdown in consumer expenditures on a drop in auto sales related to the expiration of EV credits.  We dug into it, two things.  First, EV sales are at best a contributor to slower Q4 consumer spending, not the dominant factor.  The math we ran showed that lost EV sales of -204k units multiplied by the then average unit price of $58k (Cox Automotive data) would only have represented approximately 1/4th of the lost potential retail sales growth across the economy.  But that assumes no substitution whatsoever. We must assume some meaningful majority of these would-be EV buyers then went out and bought a hybrid or an ICE car.  For reference, total auto sales dopped in October 2025 then immediately rebounded in November and December 2025.  Additionally, we used a potential retail sales growth rate of 4% vs the actual 2% growth rate in Q4 2025.  Our point is casting the expiration of EV credits as the culprit for a slowdown in economic consumption in the fourth quarter 2025 is a farce; the data shows the consumption of expensive goods pulled back, writ large, during the shutdown period.  Thus, all-told, the shutdown could have cost the US 2.0% in GDP growth annualized, which is the sum of a 1.2% drop in government spending and call it a potential 0.75% drop in consumer spending.  Normalized, we could have seen around 3.5% annualized GDP growth for the quarter and it is quite unfortunate we did not.  Who knows, could have even been better.     

PCE data came in slightly hot for the December 2025 reading.  PCE growth YoY rose from 2.8% in November 2025 to 2.9% in December 2025 (BEA).  If Core CPI is growing at a 2.5% annualized rate as of January 2026 (BLS) and PCE data is growing at a 2.9% annualized rate as of December 2025, the delta between the two can be found in each respective inflation indicator’s relative weighting of shelter inflation.  Shelter, or the relative cost to own or rent a home, represents approximately 35% of the index weighting in CPI and only 16% of the weighting in PCE.   As growth in shelter costs moderate from 8% YoY growth in 2023 to 3% YoY growth today (that’s CPI data), it’s impact on the broader downward inflationary trend is more pronounced in the CPI calculation than in PCE.   Alternatively, the PCE report picked up a notable increase in goods prices in December 2025, up 0.4% MoM, driven by a jump in durable goods prices such as recreational goods and home furnishings.  One month is no trend, we’ll continue to watch this, as will the Fed.

We would end with a warning that the present US savings rate of 3.6% (FRED data) is likely not sustainable.  Economists will tell you the stable savings rate is somewhere around 7.5%, based upon the average savings rate post-GFC through Covid.  They’re probably closer to right than wrong, in our opinion; but, 3.6% is an exceptionally low rate of savings historically and definitely reflective of an exuberant (not an extended) consumer. The definition of an extended consumer is a consumer experiencing a recession.  Not ironically, data shows savings rates jump and consumer debt burdens plummet during periods of fiscal austerity and uncertainty (oftentimes characterized by a recession).  What gets hit the hardest when a consumer must enact fiscal austerity measures is consumer spending – so please dissociate the narrative that a rising consumer debt load is indicative of a stretched consumer with the actual truth.   An lower-leveraged consumer who has used its savings to pay off its credit cards and personal loans, while spending very little on discretionary goods, is historically more characteristic of a stretched consumer.  For instance, the savings rate in 2007 was 2.4%, which jumped to 7.8% by 2009. According to the Fed, median credit card balances dropped from $4.3k to $3.6k from 2007 to 2010. The same trend happened during Covid and the Dot-Com bubble bust, amongst other historical recessions.  Alternatively, if you look at pre-crash savings rates from 1997 – 2000 and 2005 – 2007, both periods exhibit similar exuberant consumer spending behavior, with savings rates dropping below (sometimes well below) 5%.  To some extent, many of us can relate to this wealth effect impulse.  However, despite the current stock market run and real income growth levels, we all must remain vigilant and continuously invest our future.  Read the Richest Man in Babylon.  We’d like to see this savings rate move towards 5% again as it was in 2023 and for much of 2024.