2018 Q4 Prints At Just 2.6% As Economy Slows

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by: J.G. Collins
Summary

Economy slowed, as we had predicted, after some "stacking" that distorted GDP in the earlier quarters.

Continued flattening of the 3Mo/10Yr yield curve, and the decline of the 10Yr should concern investors.

We're still not seeing the kind of domestic investment in structures and equipment that would lead to robust growth, despite generous support from the new tax act.

Gross Domestic Product growth for the fourth quarter of 2018, or "2018Q4 GDP", printed yesterday morning at 2.6 percent, at the consensus estimate. The release had been delayed about a month from the government shutdown. The print was 80 bps below the final 3.4 percent reading of the last quarter, 2018Q3, but also 30 bps above 2017Q4 of 2.3 percent.

Average GDP growth for all four quarters of 2018 was 3.1 percent. That compares to average GDP growth 2017, of 2.5 percent. We had anticipated growth in the fourth quarter, at between 2.7 and 3.2 percent growth, in line with the consensus. (We raised it 0.1 percent from our 2018Q3 estimate in our jobs report.)201Q4GDP Source: The Stuyvesant Square Consultancy

2018GDI Source: The Stuyvesant Square Consultancy

All major categories of GDP declined in 2018Q4, with the biggest decline coming in Gross Domestic Investment. That, in turn, reflected a reduction in the inventory build that we saw in 2018Q3. That, in turn, was another echo, as discussed here before data revisions.

The other big echo was in the inventory build-up, an incredible 200 bps of the 3.5 percent GDP. That counteracts the big drop in inventories in 2018Q2. GDI improved substantially after a showing last quarter.

But most of that came from replacing non-farm inventories which had been substantially "burned off" in the second quarter in what was then the biggest decline in that number since 2012Q4. We had predicted a likely restocking in the remaining quarters of 2018, and it seems to have come to pass. That may continue into 2018Q4, but is more likely to decline both then and further into 2019Q1.

Personal Consumption Expenditures, or PCE, growth declined 45 basis points, to 1.92 percent, but off a strong 2.37 percent in 2018Q3 and a paltry 0.36 percent from 2018Q1, the lowest PCE quarter in recent years.

Again, this is an echo of the stacking we reported after 2018Q1, as consumers continue the "catch-up" spending they started in 2018Q2 that they had forgone in 2018Q1.2018Q4PCE Source: The Stuyvesant Square Consultancy Biggest gainers in PCE were in services (1.11 percent), comprised mostly of healthcare (0.37 percent), financial services (.25 percent) and housing and utilities (.21). In goods, which contributed 0.80 percent, comprised of durable goods (.41) and non-durable goods (.39). We expect PCE to grow in the range of 1.2 to 1.7 percent throughout 2019, particularly given recent restraint by the Fed and the February consumer confidence number.

Summary Analysis

The Short-Term View

As we had predicted in our 2018Q3 report, the strong performance in PCE and GDI we saw in 2018Q3 were not sustainable. We had predicted, then, that 2018Q4 GDP would print around 2.6 to 3.1 (we had raised it 10 bps in recent months), but we were not surprised to see it print this morning in the lower end of the range we predicted in 2018Q3. But we expect 2019 Q1 to print only in the range of 2.4 to 2.9 percent. The IBD/TIPP index of Economic Optimism for February dropped sharply to just 50.3, just barely expansionary.

We continue to be troubled by continuing volatility and flattening in the 3Mo/10Yr yield curve, which has been narrowing, on-and-off, since the end of 2017. It ended at just 25 bps Wednesday, the lowest since mid-August. Moreover, the 10 year seems to be continuing its overall decline. The decline in the 10 year shows investors are moving toward bonds; moving cash from equities to Treasuries. M2 velocity also flattened going into Q3, even as the Fed tightened the money supply.

Medium Term

We are somewhat pessimistic over the medium term because we see recent distinct signs of a slowing economy. We expect exports and consumer spending to return to rates consistent with the averages of the results we've seen in prior results we've seen since the Great Recession, +/- 50bps. We expect similar levels of inventory build, which would make GDP much more modest, in the 2.3 to 2.8 percent range in mid-2019 to earl 2020.

Long Term

Our long-term view of the economy, beyond 2021, remains unchanged. Aside from AI, there's very little in this economy we see on the horizon to create rapid, robust, growth; the "next big thing" in the way of a product or service that ramps up a sustained, substantial, uptick in production and consumption to drive growth.

The battering we saw in the FAANG sector starting in October has yet to recover. It may be that President Trump's more protectionist trade rhetoric could add foreign owned domestic production to drive GDP growth. But, so far, that rhetoric has only been a threat to induce more fair trade policies from our trading partners. Much remains to be seen.

Direct foreign investment in the USA has actually declined as trade issues ramp up. Absent growth from some major consumer-oriented innovation, or some significant re-shoring of manufacturing or other direct foreign investment in the USA, we anticipate managers will look for growth in certain low-margin industries and consolidate to realize cost savings. We also expect internet retailers, like Amazon (NASDAQ:AMZN), to realize enhanced growth by adding to their business of selling "stuff" to their nascent business of selling "experiences" - concert tickets, airlines, cruise lines, car rentals, theme parks, hotel chains, etc. In equities, we're inclined to stand pat with these sectors, as follows:

  • Outperform: Consumer discretionaries in the mid- to high-end retail sector; trucking on speculation of consolidation and acquisition; companies or REITs that own real estate in sectors identified as "opportunity zones" under the Tax Cut and Jobs Creation Act of 2017.

  • Perform: Consumer staples, energy, utilities, telecom, and materials and industrials. Lower-end consumer discretionaries, like dollar stores; the asset-light hospitality sector on speculation of stabilizing franchisee property values and room rental costs; certain leisure and hospitality.

  • Underperform: Healthcare; financials; and technology; currencies of developing nations, such as INR; some of the PIGS currencies, too.

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