GDP Growth In The 3rd Quarter Surges - Sort Of

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Douglas Adams


  • GDP in the 3rd quarter grew at an annualized rate of 2.9% for the best post since the 3rd quarter of 2014 and just slightly below long-term trend data.
  • Growth for the quarter primarily driven by the two most volatile sectors of the economy - exports and inventory spending both of questionable forward sustainability.
  • Overall demand in the greater economy, excluding exports and inventories for the 1st and 3rd quarters, posted its weakest performances since the 3rd quarter of 2013.
  • Forward economic growth for the 4th quarter and beyond remains mixed.

US economic growth through the end of the 3rd quarter turned in an above-consensus performance for the first of three estimates of growth for the period. GDP growth increased at an annualized rate of 2.9% for the quarter, the best post since the 3rd quarter of 2014, and just slightly lower than the trend of 3.094% on annualized data back to 1960, but well above the 1.4% growth level posted in the 2nd quarter. The main drivers of growth for the quarter came from the two most volatile sectors of the economy, namely exports and inventory stock. US soybean exports filled in global market shortfalls created by poor harvests in Argentina and Brazil - a one-off event that likely will not be repeated in the 4th quarter. US exports provided almost a full percentage point to overall economic growth - the largest contribution since the 4th quarter of 2013. Corporate spending on inventory stocks turned positive for the first time in five consecutive quarters. While the two sectors produced just under half of the overall GDP growth for the quarter, the sustainability of these gains into the 4th quarter and beyond is questionable.

Figure 1: Annualized Consumer Demand

Consumer spending, which provides just under 70% of GDP growth slipped markedly during the quarter to an annualized rate of 2.1%, a bit over half the level of spending posted in the 2nd quarter. Spending on durable goods fell three-fold from final 2nd quarter levels, while services actually subtracted from overall GDP growth for the quarter. Final sales to domestic purchases, a statistic that zeros in on overall demand less inventory and exports, pulled back measurably during the quarter, and in conjunction with the 1st quarter of 2016, posted the lowest level of consumer demand since the 3rd quarter of 2013 (see Figure 1, above).

Spending on residential construction fell almost as much at -6.2% as it did in the 2nd quarter, falling 7.7% annualized - back-to-back declines the dimension of which hasn't been seen since the deluge in the 3rd quarter of 2010 when residential construction fell at an annualized rate of 30.7%. New home sales for the month of September advanced 3.1% over August to an annualized rate of 593,000 units - almost a 30% gain over September 2015. The median selling price of new houses rose to $313,000 for the month - shy of the $321,300 peak price reached in April, but well north of the $262,600 reached in March 2007 almost a year after the national peak of existing home prices in April of 2006. Since March of 2007, new home prices have increased just over 19%. In way of comparison, median weekly real wages increased over the same period by 3.58%. On existing home sales, which constitute about 90% of the market, total sales advanced 3.2% in September to an annualized total of 5.47 million units, with inventory falling 2.3% during the month to the tightest monthly supply since March at 4.5 months. Year over year, existing home sales eked positive at 0.6%. The median sales price fell to $234,200 in September, down 2.38% for the month, but up 5.4% on September 2015. The average selling price for the month came to $276,200, which was also down from August's $282,000 as high-end home sales continue to skew prices to the upside, while low-end homes figure less in the overall mix due to a plethora of causes - including the lack of starter home inventory in many markets and stricter lending standards keeping first-home buyers on the sidelines. Meanwhile, consumer confidence measures edged down slightly for the month to a reading of 87.2 on the University of Michigan survey and to a reading of 98.6 on the Conference Board survey - a downtick not uncommon for election years.

Weak demand begets weak supply: Economic theory tells us that weak demand often becomes a self-fulfilling prophecy which holds the potential to wreak havoc on future economic growth. When businesses don't invest, consumers tend to follow suit, driving down productive capacity of the economy, threatening job and earnings growth - not to mention GDP growth - in the greater economy. True to form, capital goods investment contracted 1.2% in the greater economy during September month over month and declined 3.9% in September 2015. Corporate expenditures on equipment has declined for the fourth consecutive quarter as the investment pullback in the oil sector continues to be a strong headwind to overall investment growth in the corporate sector. That said, the decline in equipment expenditures was the lowest post of the year, perhaps portending a signal that the worst of the declines in the oil patch are behind us. Investment in long-haul truck, aircraft, railroad and related equipment has contracted for the past four consecutive quarters, as corporate decision makers continue to hold back on investment in the face of continuing economic uncertainty. Nonresidential fixed investment posted small back-to-back quarterly gains only to be overwhelmed by the pullback in residential construction which pushed overall fixed investment into contraction for the past four consecutive quarters. Interestingly, spending on warehouses, office buildings and other corporate structures jumped 5.4% through the end of the 3rd quarter after falling 2.1% in the 2nd quarter. It was the biggest jump in structural spending since the 2nd quarter of 2014. Corporate spending on inventory stock occurred after five consecutive quarters of investment contraction is more attributable to finally having to restock depleted shelves and warehouses that have finally been sold off rather than a sign that overall demand curves have decidedly shifted. Industrial production edged up in September 0.1% after falling in August by 0.5%. Year-over-year industrial production fell a full one percent with final products, business equipment and materials all falling year over year through September with mining (down 9.4%) and utilities (down 0.4%) leading the annualized downward spiral. Total industry capacity utilization remains stuck at roughly 75% for the balance of this year, down from its 43-year average of 80%.

While corporate decision makers are clearly spending less on plant and equipment in the recent past, the one clear standout spending category that has largely avoided budgetary austerity measures has been research and development. Through the end of the 2nd quarter, corporate spending on research and development soared 11.8% on an annualized basis - the strongest post since the 3rd quarter of 2006. In the 3rd quarter, the category added another 2.1% annualized bump in overall spending in the 3rd quarter. R&D spending has remained fairly steady throughout the financial crisis years and into the recovery as companies are loathe to lose their technological edge in the competitive marketplace almost without regard to ambient demand in the greater economy. A technology or drug company without a working product pipeline falls out of the competitive market quickly.

Government investment remains weak as political differences between the major political parties continues to be a major impediment to outlining spending priorities - with little relief expected in the immediate and medium terms. That political divide is now longstanding, sending government spending to a level not seen since the 1950s as a percentage of total GDP. Fiscal spending on infrastructural projects across the country are, encouragingly, talking points in both party platforms, yet getting such spending programs through a divided congress remains a Herculean task. Meanwhile, state and local government investment has fallen for the past two consecutive quarters and has fallen in three of the past four quarters leaving many municipalities still struggling with the aftermath of recession and associated declines in tax revenues that continue to weigh heavily on growth. Bond floats at the state and local level are more likely earmarked to retire existing debt at higher interest rates than to raise funds to finance new projects - despite historically low borrowing costs.

Headline PCE inflation remained unchanged in September from August, up 1% on prices observed in September 2015 - the highest level since the 4th quarter 2014. Core PCE, which excludes food and energy prices, ticked up to 1.7% through the end of the 3rd quarter - its highest post since the 4th quarter of 2012. The more familiar CPI was up 0.3% in September, the highest month-over-month post since April. Prices were driven by energy increases with the price of gasoline up 5.8% for the month after falling 0.9% in August and 4.4% in July. Shelter costs, a big component of the index, shot up 0.4% for the month for the largest increase since October of 2006. Headline CPI inflation increased 1.5% on September 2015 prices. At the core level, prices rose 0.1% on the month and 2.2% on September 2015.

Core CPI inflation has been running well above core PCE inflation due to differences in weights given in each of the surveys to rents and medical prices and was duly noted in the minutes of the Fed's September meeting. With core PCE inflation still running below the Committee's 2% target, the argument for keeping the federal funds rate at its current level remains appropriate - the consensus that emerged out of the September meeting - despite three voting governors dissenting on the final vote.

Bond investors worldwide appear not to be taking any chances with either price inflation or a second increase in the federal funds rate since 2006. Rising prices in the greater economy erodes the value of bond income and principal. In the US, the yield on the 10-year Treasury note surged to a market close of 1.849% on Friday (29 October); its highest yield since early June. The German 10-year Bund closed at 0.168 while the yield on 10-year gilt closed at 1.157%. The German 10-year bund hasn't carried such a yield since May. Japan's 10-year Treasury note remains negative at 0.046% - its highest post since early September. Given investors have been weaned on an environment so dramatically shaped by years of low interest rates and even lower rates of inflation, any movement, however small in yields across international borders, will have an outsized impact on bond markets worldwide.

All eyes now turn toward the Federal Reserve. Inflation remains largely quiescent and economic growth remains tempered but largely steadfast. The unemployment rate peaked in October 2009 at 10%. Through September, that rate has fallen by half to 5% without triggering the price inflation of past recovery periods, signaling there is still slack in the labor market. That remaining slack is one of the main reasons why wage growth remains subdued. Residual slack in the labor market also explains why we still have 7.9 million workers looking for work and why another 5.9 million workers have been forced to settle for part-time positions because full-time work is unavailable.

These are the economic issues the Fed continues to ponder. The November FOMC meeting this week is fully expected to be anti-climactic in regard to any vote on increasing the federal funds rate. The November meeting will largely play the role of possibly setting the stage for a rate increase in December, the Fed's last chance to pull the trigger in 2016 - in a year that began with projections of four such rate increases. An increase in the federal funds rate by the end of December carries a 66% probability - not a foregone conclusion by any means, but likely the closest we've been to a triggering event all year. The forecast for economic growth for the 4th quarter and beyond, however, remains mixed.

This article was written by

Douglas Adams profile picture
Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.

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.

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