Q2 US GDP Was Iffy. Markets Already Knew.

Strong. Weird. Moderate. These are just some of the words we saw headlines use to describe Q2’s US gross domestic product (GDP, a government-produced measure of economic output) report, which boasted a 3.0% annualised growth rate.^[i] May we offer an alternative? Iffy. Maybe borderline bad. We don’t think this is a negative surprise for forward-looking stocks, mind you, but evidence of tariffs’ economic ills. We think stocks are correct to continue looking 3 – 30 months out, to a time when tariff uncertainty is likely lower and businesses are moving forward. In other words, we remain bullish on global stocks. But we think a clear-eyed economic view is necessary to judge whether sentiment veers too far from reality from here. 

To us, Q2’s report looks like the inverse of Q1’s. Then, GDP fell -0.5% annualised, but private demand components were strong.^[ii] The negativity came from surging imports, which rose 37.9% annualised as Americans scrambled to beat potential tariffs.^[iii] GDP math employs net exports (subtracting imports from exports to try to isolate single-country output), so this offset rising consumer spending and business investment. Q2 brought the opposite. Imports plunged -30.3%, probably a mix of pulled-forward demand creating a pothole and tariffs’ generally discouraging trade.^[iv] Exports also fell, down -1.8% annualised, as the rest of the world worked through the stockpile of US goods it seemingly raced to buy in Q1.^[v]

We don’t think this was hard to foresee, given all the attention paid to tariffs globally. But beyond trade, things seem less than rosy. Consumer spending accelerated to 1.4% annualised, which commentators we follow cheered since this is America’s largest economic segment.^[vi] Problem is, our research suggests consumer spending isn’t a swing factor. Most of it goes to services and tends to be pretty stable.^[vii] We find business investment is more of a swing factor, and it slowed considerably, from 10.3% annualised in Q1 to 1.9%.^[viii] Most of that growth came from equipment, which seems to us like businesses racing to buy machinery from Japan and Taiwan before the reciprocal tariff pause expired—something we think trade data from the US, Japan and Taiwan all hint at.^[ix] Meanwhile, investment in structures fell -10.3% annualised, extending Q1’s decline.^[x] And research & development notched its third straight decline, falling -1.6% annualised.[xi] Both suggest to us businesses are becoming more risk-averse as tariff uncertainty clouds the landscape.

If the US falls into a tariff-induced recession (period of contracting economic output), we think this is where it would come from: businesses’ putting longer-term plans on hold as they wait for clarity. Our research suggests uncertainty reigned throughout Q2, which included almost all of US President Donald Trump’s 90-day reciprocal tariff pause window.^[xii] Now we are staring down a fresh deadline, 1 August, without much more clarity. Yes, the US has a few deals, but the big ones are scant deals to make a deal, with disagreements already bubbling with Japan and the EU.^[xiii] Meanwhile, we are seeing a lot of can-kicking with China, and the appeals court case that began today is another wild card, in our view.^[xiv] If you are running an American business, do you deploy a long-term investment now, knowing you may need to reorganise your entire supply chain depending on how things go over the next several months? Or do you wait?

We are seeing mounting evidence many US businesses are waiting. Core capital goods orders, which our research finds are a leading indicator of equipment investment, fell in three of the last five months.^[xv] We think inventories’ Q3 will be a litmus test. Businesses ran them down in Q2, detracting -3.2 percentage points from headline GDP’s growth rate, after stockpiling in Q1.^[xvi] Will they replenish in Q3? Or will the longer-running drawdown that started at 2023’s end continue?^[xvii]

These are the things we will be watching, along with sentiment’s evolution. For now, sentiment seems mostly in check. We have seen plenty of chatter about tariffs’ being a political and diplomatic win for the US, but when the discussion turns to the economy, commentators we follow have been much more measured. We have observed a sprinkling of optimism, but also a lot of the worst isn’t here yet. In our view, this extends the bull market’s wall of worry, which keeps iffy reports like Q2’s from being a negative shock.^[xviii] We find bull markets are very good at rising through economic rough patches when expectations aren’t outlandish. Our research shows stocks move most on the gap between reality and expectations, and we think that gap remains decently wide.

So we are bullish, even as we look what we think is an iffy-to-bad report in the eye. When stocks priced worst-case-scenario tariff expectations in April, we think widespread recession chatter was a key contributor.^[xix] And as businesses gain clarity, our research suggests they should become less risk averse. But it is entirely possible we see some more iffy (or weaker) reports before we get there.