Today's GDP Report Weaker Than Headlines Suggest

Includes: IYY, SPY
by: William Trent, CFA

The Bureau of Economic Analysis released the revised 3rd quarter GDP report, which the market has received with enthusiasm. According to Yahoo! News:

The U.S. economy grew faster than first thought in third quarter on strong business investment, even as the housing sector posted its biggest decline in more than 15 years, the government said Wednesday.

After-tax corporate profits during the quarter were far stronger than expected, and will likely reinforce expectations that Federal Reserve policy-makers would keep interest rates unchanged for the next few months.

While it is true that profits were up sharply (31.5% from the year-ago quarter), cash flow growth was in line with recent trends. To us this suggests that the profits reading was probably anomalous.

profit cash flow

The article, however, gushes past this:

Even so, business spending was stronger than first thought according to the Commerce Department report, which was the second estimate of the third quarter figures after an initial report issued last month.

Business spending rose at a 10 percent annual rate, up from the 8.6 percent rise first estimated. Corporate profits during the quarter, after taxes, advanced by 4.6 percent. That was far above the scant 0.3 percent advance in the second quarter and surprisingly higher than the 0.4 percent gain economists in a Reuters poll were expecting.

Really? Here’s our chart of the year/year change in business investment on equipment and software:


To us it still looks like a significant slowdown. So where is the discrepancy? According to the article:

Business spending on inventories increased at a $58 billion rate, sharply higher than the $50.7 billion earlier estimated.

Higher inventories won’t do any good unless consumers buy them. If they stay on the shelves, today’s surprise gain will simply equate to tomorrow’s surprise shortfall.