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Hello and welcome to Notes in the Week Ahead, a JP Morgan Asset Management podcast that provides insights on the markets and the economy to help you stay informed in the week ahead. Hello, this is David Kelly. I'm Chief strategist here at JP Morgan Asset Management. Today is February 17, 2020 26. Between taking a shower when I get up in the morning and another when I get home from running, I am a significant consumer of detangling solution. In my youth, an unruly shock of hair required liberal doses of the substance just to bring some order to my muppet like locks. Today, sadly, the forest has thinned out, making detangling solution somewhat less necessary. However, with less to do up top, it would be nice if it could gently seep into my scalp detangling. Some of the confusion beneath this is particularly the case today when all the major economic trends, including growth, jobs, profits and inflation look tangled and distorted. However, in the absence of a chemical remedy, there seems to be no alternative to going through them one by one, teasing out the knots and distortions in order to get a clearer picture of the investment environment. On Friday, the Commerce Department will finally report on real GDP growth for the fourth quarter of last year. Even now at this late stage, there is a wide range of forecasts for this number, with the Atlanta Fed's model predicting 3.7%, while our own forecast is just 2.6%. This wide range is mostly due to swings in trade and inventories triggered by the sharp increase in US Tariffs early last year. December data on business inventories in international trade and goods due out on Wednesday and Thursday, should bring some belated clarity to the fourth quarter growth picture. Either way, however, year over year, real economic growth should look solid, rising 2.5% in our view of the world and 2.8% according to the Atlanta Fed. How about 2026? Well, starting with consumer spending, tougher winter weather hurt light vehicle sales in January, cutting annualized sales to 14.9 million units compared to a 15.7 million pace in the fourth quarter. Other areas of retailing, leisure and hospitality also appear to be badly impacted by the weather. Meanwhile, what promises to be a bumper season for income tax refunds is actually off to a slow start, with just $16.9 billion paid out in refunds through February 6, up only 2% from the same week a year earlier. We expect this to pick up markedly in late February and in March, boosting consumer spending in the second and third quarters. We also expect the administration to try to push through so called tariff rebates in the form of one time checks to households over the summer, boosting consumer spending through the third quarter. Beyond this, spending by upper income households is being aided by the wealth effect of three years of a booming stock market and conversely, much lower net immigration. And weak job growth will act as a drag on spending that should reassert itself in the fourth quarter and moving into 2027. Business fixed investment should be strong in upcoming quarters due to favorable tax treatment and the extraordinary build out of infrastructure related to the AI boom. However, other areas of investment spending, including spending on structures outside of data centers and electricity infrastructure, inventory accumulation and home building, should remain weak. International trade should have a relatively neutral impact on growth as imports stabilize at a lower level in response to tariffs. Meanwhile, government spending will likely be held in check by continued federal cutbacks and lack of sales and property tax revenue growth at the state and local level. Putting it all together, we expect real GDP growth to start the year at just 1% annualized, speed up to over 3% in the second and third quarters, and then slip back to 1% in the fourth quarter, adding up to 2% growth for the year as a whole. Economic growth in 2027 may fall to 1.5% annualized. This would be in part due to a lack of fiscal stimulus. If Democrats take back control of the House in November and balk at any further White House proposals for unfunded tax cuts or unfunded stimulus checks, it would also reflect a simple lack of labour supply. Last week's January jobs report was positive on the surface, with nonfarm payrolls rising by 130,000 compared to consensus forecasts of 70,000 and the unemployment rate slipping to a six month low of 4.3%. However, job gains for November and December were revised down by a combined 17,000. It's also noteworthy that with the annual benchmark revision to the Establishment Survey, December payroll employment was revised down by over a million jobs so that by January, average monthly job growth over the past year was an anemic 30,000, including outright declines in the mining, manufacturing, transportation and government sectors. The February jobs report, due out on March 6, should see a similar correction to the household survey. For some bizarre reason, when the Bureau of Labor Statistics incorporates new census population estimates in January of each year, they refuse to adjust the population numbers of the prior 12 months. So household survey measures of labor force employment and unemployment either jump or dive at the start of each year. This year, while the adjustment will initially be made to February data rather than January data, it'll be a dive with a potential reduction in the civilian non institutional population of about 733,000 relative to what it would have been under the old population trend. This should fix the current discrepancy between the reported year over year 647,000 growth in non farm wage and salary workers according to the household survey and just 359,000 non farm payroll jobs according to the establishment survey. Once this is resolved, however, population projections should look sobering. It now appears that the BLS will project an increase in civilian non institutional population aged 16 and older of roughly 85,000 per month over the next year, compared to 191,000 per month over last year. Moreover, this growth will be more than accounted for by the growth in the elderly population. We expect based on census data, that the population age 18 to 64 will fall by roughly $20,000 per month for the rest of this year. If this is the case, then even as economic growth accelerates over the middle of this year, payroll job growth should remain relatively anemic, averaging about 60,000 per month over the course of 2026, with strong productivity gains in unemployment falling back towards 4% next year. In the absence of fiscal stimulus, demand growth should slow so that 1.5% real GDP growth over the course of 2027 could result in an unemployment rate that is relatively stable at 4%. The fourth quarter earnings season is winding down with 79% of S&P 500 market cap reporting as of last Thursday. Overall, it's been a very strong quarter with year over year gains in profit pro forma earnings of 12% and 79% of firms beating earnings expectations for 2025 as a whole. It now appears that the index achieved double digit earnings growth for a second consecutive year and analysts expected to repeat this feat in both 20 and 2027. It will be hard to meet these lofty expectations. The MAG7 company still contributed over 50% of the earnings growth seen in the fourth quarter, and this is in turn being powered by huge capital spending. As a simple matter of accounting, if tech company A buys $50 billion in equipment from tech company B, company A treats it as capital spending and depreciates it with only a fraction of its costs hitting the income statement, while Company B treats it as revenue with all of it after subtracting variable costs falling to the bottom line, investors are getting nervous about the ever larger capital spending commitments of the hyperscalers, presumably because in the years ahead, the accumulating expense of depreciating past capital spending or any pullback in future capital spending would have a negative impact on tech earnings elsewhere. Many public and private companies are benefiting from the AI Guild rush, and firms focus on the spending of high increments. Consumers are generally doing well, as are financials. However, other companies selling their wares to the broad mass of American consumers are having a more difficult time, and tariff costs, slow growth in demand and a lack of labor supply will all be headwinds going forward. In a slow growing economy, double digit earnings growth won't be sustainable for long, making it more urgent that investors focus on individual corporate prospects and valuations rather than relying on a generally rising tide of corporate earnings and then there's inflation. Last Friday's CPI report was surprisingly benign, with headline inflation of 2.4% year over year compared to a 2.5% consensus expectation. Part of the reason was a sharp 1.8% decline in used car prices, a trend that is unlikely to be sustained for long given relatively tight inventories. Gasoline prices were also down in January, although they are likely to rebound in February. More importantly, however, shelter inflation has been falling steadily while both health insurance and auto insurance costs are now falling. According to the government's calculations. These slow moving, smooth series tend to lag marketplace reality and, having slowed the decline in inflation between 2023 and 2025, are now steadily dragging inflation down. While there are significant measurement problems in these indices, the most important of them shelter costs, are seeing genuine weakness in industry data and could well lead CPI inflation to fall below 2% entering 2027. Between now and then, however, CPI inflation will likely jump back to over 3% this summer as businesses feed through tariff costs to consumers, who will be temporarily flush with income tax refunds and stimulus checks. My chosen detangling solution, despite having a sophisticated brand name and instructions prominently displayed in French, is, as far as I can tell, pumped out by a factory in Kentucky. Still, such is the power of marketing, and I've been using the same brand for many years. Similarly, I've been using the same brand of economic forecasts for a number of years. At the end of 2023, I thought a good description of the outlook for 2024 was 2024 2% growth, zero recessions, inflation coming down to 2% and unemployment at roughly 4%. And despite the sharp contrast between very gloomy consumer sentiment and still sparkling stock market, when you detangle the data, the same moderate forecast emerges. Unless and until some shock hits the economy, the outlook remains one of mild and steady growth and moderating inflation and unemployment. For investors, this implies that rather than just worrying about the big picture. They should focus on the valuations of prospects across a wide range of financial assets and whether their portfolios are appropriately balanced for where they are in life. Well, that's it for this week. Please tune in again next week. And if you have any questions in the meantime, please reach out to your J.P. morgan representative.