The Good News And The Bad News In The Recent GDP Report

by: BubbleBustInvesting

Summary

Strong consumer spending helped Q4 GDP rise by 1.4%, ahead of expectations.

But corporate profits declined.

And the GDP deflator edged higher.

That may re-ignite fears of higher rates.

There's good news and bad news in today's Q4 GDP report. For Wall Street, that is.

The good news is that the American consumers continue to spend at a healthy pace, saving the ongoing economic expansion. Consumer spending, which accounts for close to 80% of the real GDP, rose by 2.4% in the last quarter of 2015 - well above the 2% reported last month.

That has resulted in a revision of GDP from 1% to 1.4%. Not that bad at a time when Europe is barely growing, Japan is floundering in the swamp of a two-decade long stagnation, and China continuing its own descend.

There are several explanations for a strong consumer showing in 2015. First is the ongoing ultra-low interest rates, which have provided for low cost financing for high-ticket purchases. For consumers with a good credit standing, that is.

Then is rising home prices, which have helped consumers tap into home equity lines for the purchase of high-ticket items.

Third comes a strong February payroll report, which is expected to boost consumer income.

Then comes savings from the lower gas and heating oil prices, which have acted as a sizable tax cut, especially for low-income consumers. That's certainly music in the ears of Wall Street traders, especially those betting on retailers and domestic restaurant chains.

The bad news is that corporate profits continued to decline for a second quarter in a row.

There are good explanations here, too. First, there's the strong dollar, which has gained close to 10% last year against major currencies. That has shaved a few percentage points off the top line of the large US corporations with a big overseas exposure, as evidenced by recent corporate reports (e.g., Nike (NYSE:NKE) on Wednesday).

Second is the decline in oil prices that has caused severe losses to major American oil producers, especially frackers, which have a high production cost in the first place.

But wait, there's more bad news: The GDP Deflator, an inflation gauge closely followed by the Federal Open Market Operations Committee (FOMC), rose by 0.9% in Q4.

A strong GDP deflator together with strong consumer and employment data is expected to widen the rift between hawkish and dovish FOMC members, and eventually tip the balance towards the hawkish camp. That's bad news for Wall Street, which has been fixated on the FOMC actions for the last seven years. And that could explain the dollar rally following the release of the GDP report.

Still, one report doesn't set a trend. Investors should pay close attention to subsequent reports to determine the direction of the US economy. Especially, investors should watch for the next Friday's March payroll report before they make any major adjustments in their asset allocation strategy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.