Stock Market Misread - Q2 GDP Actually Beat Forecasts After Accounting For Q1 Adjustment

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Includes: DIA, IWM, QQQ, SPY, UUP, XLB, XLE, XLF, XLK, XLP, XLU, XLV, XLY
by: Markos Kaminis
Summary

The initial reaction of investors this morning to the Q2 GDP report seemed to indicate a misreading of the data versus economists' expectations and also concerns about outstanding issues.

Second quarter GDP fell short of economists' expectations, but after accounting for a significant upward adjustment to the prior reported Q1 GDP data, reflected healthy activity.

Even so, investors remain worried about the potential impact of China economic growth deceleration and U.S. energy sector underperformance.

The U.S. Federal Reserve's monetary policy plans continue to weigh on markets as well.

Stocks should recover today as the market better understands the GDP result. I expect significant volatility into this fall, but suggest long-term investors use any significant weakness to buy stocks.

In its first reporting, second quarter GDP was reported up 2.3% this morning. Stock futures were edging lower into the release and stocks accelerated their pessimism after the news. Take heed though: While the data was lower than economists' consensus expectations at surface inspection, there was a significant upward adjustment to the first quarter data that when taken into account would make this data more than acceptable. If stocks were to accurately reflect the message of this data, then they would be rising today. Thus, as the data is better understood, stocks should benefit, and I fully anticipate a market closing in the green today or recovering tomorrow. However, there is a caveat, which is that China economic growth deceleration (with a watchful eye on Europe as well) and energy sector troubles do not infect the U.S. economy significantly in the months ahead; and that the Fed will not err in its decision making. If you believe that is the case and you are a long-term investor willing to bear likely near-term volatility, then you own stocks but with powder dry on the side to invest on any significant decline between now and the end of the year (it is well overdue and will probably come).

The advance estimate of Q2 GDP showed the economy grew 2.3% in the first quarter. That was below the economists' consensus of 2.9%, as reported by Bloomberg, and also short of the 2.6% figure I heard quoted by Fox Business News this morning. In other words, on the surface, it was bad news. However, as my followers well know, we do not stop at the headline.

A critical point about today's data is that it was calculated on the basis of a Q1 estimate that has been subsequently revised significantly higher. The Bureau of Economic Analysis reports that Q1 GDP, previously reported at contraction of 0.2%, has been revised to now reflect growth of 0.6%. That is a big change of 0.8 of a percentage point. If economists calculated their absolute GDP level off of the adjusted Q1 GDP level, then today we might be saying the Q2 GDP growth beat expectations and stocks would be celebrating the good news. Instead the market focused this morning on what appeared to be a slower level of growth than was anticipated, and it is looking toward two key stumbling blocks for future drag.

What is Really Troubling the Market Today

The market is overly concerned about China economic growth deceleration and its potential impact on the U.S. economy. China's growth has to slow from time to time folks. No economy can smoothly grow without experiencing troughs and cycle peaks, as we are human and we overreact and exaggerate spending and saving at cycle extremes. There's real concern about the exaggerated growth of China though, and the excess spending on infrastructure and real estate in advance of need. Still, it's a bit too early for this concern to seriously threaten U.S. stocks on more than a short-term basis. Data from China, however suspect, still varies and offers mixed messages while still reflecting significant growth generally. Thus, soft China data or turmoil in its financial markets fades in its impact on U.S. equities. It would take a meaningful economic downturn in China to begin to truly shake global markets on a sustained basis. I just do not see that happening yet given China's potential and its efforts.

What really matters now more than anything to the U.S. economy is actually the U.S. energy sector issues caused by the dramatic drop in energy prices. Time and again over the past year we have been swept off course by cross currents in our economic data. Employment is improving generally and consumer spending is strong for the most part, but business activity related to energy exploration and production and other business activity in geographic centers of energy (like Texas) are underperforming. Indeed, I am sure this latest GDP data point would have exceeded 3.0% if not for energy sector softness. But however important the energy sector is, the benefits of lower energy prices outweigh the costs for the whole of America. It would just be nice to find equilibrium.

Sector Security

07-30-15 Midday

YTD

TTM

SPDR S&P 500 (NYSE: SPY)

-0.1%

+3.5%

+9.1%

SPDR Dow Jones (NYSE: DIA)

-0.1%

+0.8%

+7.3%

PowerShares QQQ (NASDAQ: QQQ)

+0.2%

+8.9%

+16.3%

iShares Russell 2000 (NYSE: IWM)

+0.3%

+3.3%

+8.6%

Energy Select Sector SPDR (NYSE: XLE)

-0.6%

-9.0%

-25.9%

Financial Select Sector SPDR (NYSE: XLF)

-0.0%

+3.1%

+12.5%

Technology Select Sector SPDR (NYSE: XLK)

-0.06%

+4.2%

+9.2%

Health Care Select Sector SPDR (NYSE: XLV)

-0.4%

+11.8%

+24.3%

Consumer Discretionary Select Sector SPDR (NYSE: XLY)

+0.1%

+12.0%

+20.4%

Consumer Staples Select Sector SPDR (NYSE: XLP)

-0.3%

+5.5%

+17.8%

Materials Select Sector SPDR (NYSE: XLB)

+0.4%

-5.0%

-5.8%

Utilities Select Sector SPDR (NYSE: XLU)

+0.9%

-7.3%

+6.8%

- YTD and TTM data from Seeking Alpha pages

By the time I got to this point of the report, the major indexes had impressively recovered rather significant morning losses. The SPDR S&P 500 will likely be in positive territory by the close as this more sensible viewpoint of the quarterly GDP data is commonly understood.

Day Chart of SPY at Seeking Alpha

For the market to continue its rising trend, it will need to see healthy U.S. economic growth first and foremost. The market would be supported by a recovering Europe and stabilizing China, and lags in that development would limit our upside. Finally, the Federal Reserve must act appropriately in its monetary policy making, but that does not mean it should refrain from raising interest rates. We need rate rise justified by economic health.

This latest GDP data, given the Q1 adjustment, likely gives the Fed more reason to raise interest rates as early as September. Dollar (NYSEARCA: UUP) appreciation today seems to concur that message, but the dollar gains started in overseas trading and may reflect interpretation of the Fed's Monetary Policy Statement release from yesterday, which shared greater confidence about employment.

Investors should keep a watchful eye on monthly economic data for signs about the U.S. economy, which should dictate how the Fed acts in September. Expect near-term volatility and possibly a stock market correction between now and October's end, as institutional capital flow factors and potential Fed action come into play, but long-term investors will likely be served by purchases on such weakness. For more of my regular coverage and analysis of financial markets you may follow my column here at Seeking Alpha.

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.