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The strange reason America’s economy is shrinking

<i>Brandon Bell/Getty Images</i><br/>A customer shops for nutrition products in a Walmart Supercenter on July 8 in Houston
Getty Images
Brandon Bell/Getty Images
A customer shops for nutrition products in a Walmart Supercenter on July 8 in Houston

By Julia Horowitz, CNN Business

When you think about a shrinking economy, what comes to mind?

Factories shutting down. A wave of job losses and few open positions. Huge financial losses that batter most industries.

That’s not what America is seeing right now, even though the country’s gross domestic product has declined for two consecutive quarters, meeting one technical definition of a recession.

So what is happening, and where could we be headed? The answer to both questions could be found in the country’s stockrooms.

Breaking it down: US GDP for the second quarter fell at an annualized rate of 0.9%, according to the first reading from the Commerce Department published Thursday. That followed a contraction of 1.6% during the first three months of the year.

The data stoked debate about whether the United States is already experiencing a recession, which economists have warned is a risk as the Federal Reserve hikes interest rates and inflation curbs consumer spending.

Fed Chair Jerome Powell, for one, doesn’t think this moment has arrived — at least not yet.

“I do not think the US is currently in a recession,” Powell said earlier this week. “There are just too many areas of the economy that are performing too well.”

But GDP doesn’t just turn negative on its own, and Thursday’s data contains useful guidance for understanding a complex economic moment.

Pay attention: Inventories, or goods held by a business that haven’t been sold yet, had a major role to play.

Companies stocked up on many items late last year as they attempted to dodge supply chain problems and ensure they could meet resurgent demand.

But in recent months, they’ve realized they have too much stuff, especially at an uncertain moment for manufacturers and shoppers, and become hesitant to place new orders.

The subsequent slowdown in inventory accumulation contributed to a large chunk of the contraction between April and June, removing a whopping two percentage points from economic output.

Why it matters: Some economists and investors think that because growth was pulled forward at the end of 2021, activity in the first half of 2022 looks artificially low.

“The fourth quarter, to me, was bloated a little bit,” said Anna Rathbun, chief investment officer at CBIZ Investment Advisory Services. “Everyone was just hoarding things.”

But that doesn’t mean inventory levels should be disregarded. In fact, they contain helpful clues when monitoring how fast the US economy could decelerate from here on out.

Ed Cole, managing director of discretionary investments at Man Group, told me there’s two main reasons he’s closely watching the speed at which US inventories grow “as an indicator of where we are in the cycle.”

  • If customers are buying fewer products, companies won’t place new orders, which will weigh on factory output.
  • If companies are forced to get rid of unwanted inventory with hefty discounts, it will put pressure on revenue and profits.

“Recent warnings by large retailers have demonstrated this effect quite clearly,” he added.

See here: This week, Walmart slashed its profit outlook, warning that customers are changing their shopping habits. That’s requiring markdowns to clear out excess inventories of products like clothing.

It’s not the only company with this problem. American Outdoor Brands recently told analysts that “rapidly rising inflation and interest rates … have served to drive up inventory levels.” Hasbro also said it had “higher-than-typical inventory levels” for this time of year, though it emphasized its stock is “extremely high quality.”

Amazon dodges the tech slump

Amazon is going strong even as other Big Tech companies stumble.

The e-commerce giant on Thursday reported net sales of more than $121 billion between April and June, a 7% increase from the same quarter last year and higher than Wall Street’s estimates.

Investor insight: Amazon stock surged 12% in premarket trading as investors shrugged off the company’s $2 billion loss, which it attributed in part to its investment in electric truck manufacturer Rivian.

The focus is instead on the company’s guidance for its current quarter, which ends in September. Amazon expects net sales between $125 billion and $130 billion, a jump of as much as 17% from last year.

“Big Tech’s been a mixed bag this earnings season, but Amazon proved that the strong can survive even the toughest environments,” Hargreaves Lansdown analyst Laura Hoy told clients.

Meanwhile, Apple looked less impressive. The world’s most valuable tech company reported revenue of $83 billion, up just 2% from last year and a marked slowdown from the breakneck growth it saw in 2021. Profits declined by nearly 11%.

Still, Apple beat estimates, sending shares up more than 2% in premarket trading.

My thought bubble: Even corporate behemoths aren’t immune to pressure from an economic downturn, but they are better insulated.

Having a cloud services business certainly helps. It was a bright spot for Microsoft and Google, and Amazon Web Services posted a profit of $5.7 billion. The unit’s revenue nearly hit $20 billion, a 33% increase from the same period last year.

China’s leaders have gone silent on economic goals

China’s top leadership has gone quiet on the growth targets it had set for the year as the world’s second-largest economy battles an economic slowdown that’s largely self-inflicted.

In early March, China’s government had said that the country would aim for gross domestic product to rise by about 5.5% this year. It was China’s lowest official target for economic growth in three decades. Even so, economists have said it looks increasingly out of reach.

See here: Earlier this week, the International Monetary Fund lowered its forecast for GDP growth in China to just 3.3% this year as Covid-19 lockdowns and a crisis in the real estate sector weigh on its expansion.

Now, the country’s leadership has fallen silent on growth targets altogether, my CNN Business colleague Laura He reports. At a key meeting of top leaders on Thursday, there was no mention of GDP targets.

According to analysts, this is a sign that the government thinks it might not be able to meet its goals after all.

“In today’s meeting, policymakers used the new phrase: ‘Strive to achieve the best result.’ It means that they no longer view 5.5%, or even 5% as achievable for this year,” said Larry Hu, chief China economist at Macquarie Capital.

Up next

Chevron, Bloomin’ Brands, ExxonMobil, Newell Brands and Procter & Gamble report results before US markets open.

Also today: The Personal Consumption Expenditures Price Index arrives at 8:30 a.m. ET. It’s the inflation measure watched most closely by the Federal Reserve.

Coming next week: The US jobs report for July will be closely scrutinized for evidence the economy is slowing faster than expected.

— Martha White, Alicia Wallace, Rishi Iyengar and Clare Duffy contributed reporting.

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