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Q3 GDP: Quick Read Of First Print

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by: Trading Places Research
Trading Places Research
Long/short equity, value, long-term horizon, Growth
Summary

The preliminary growth rate of 1.9% came in a little above expectations, but is still slowing. Nonfarm inventories continue to dominate.

Consumption came off its Q2 highs. We are beginning to see a little inflation in the goods economy, likely from the trade war.

Despite a rebound in residential, fixed investment tanked.

Core PCE inflation remains below the Fed target in in the YoY, but not the QoQ window.

Wages/salaries growth remained strong, but income growth is down.

This is a quick review of today’s Q3 GDP report. Full analysis forthcoming. All data from BEA’s NIPA tables.

Live video of the US economy.

Slowing

I was expecting the preliminary annualized QoQ growth of Q3 GDP to come in at 1.7% or 1.8%, but it printed at 1.9%. Higher than I thought, but still maintaining the slowing trend. Moreover, every quarter for over a year now has been dominated by nonfarm inventories.

Those relatively small blue slices are the rest of the economy. A huge portion of the growth is going into warehouses and car lots, and many companies in the durables industries where much of this is concentrated, like Home Depot (HD) and Caterpillar (CAT), are trying to dig themselves out of this hole.

Preliminary Data Is Preliminary

As usual, caveats apply when looking at preliminary data. There are often very large revisions that change our view of the quarter. We just had a recent example of this with 2018 Q4:

These are giant changes 5 months after the first print and 8 months after the quarter ended. So, grain of salt.

Incomes

Income growth was down this quarter, as were salaries and wages. Real disposable income per capita, the bottom line of the income tables, remains positive. This is the most important thing - disposable incomes are outpacing population growth and inflation.

This remains the brightest spot on the tables. However, too much income continues to go to savings:

This is exacerbating our biggest macro problem: too much savings.

Consumption and Prices

Q2 saw a huge bump in personal consumption, but that pulled back in Q3:

Despite another good quarter for core goods, core services growth (two-thirds of all PCE) has been slowing considerably since Q4 2018 and is dragging down the overall core PCE number (the blue column). That’s one we always want to see above 4%.

Looking at YoY price inflation, it remains below the Fed’s target:

The overall GDP inflation has come down from 2.6% in Q2 2018 to 1.7% now, matching core PCE inflation. However, if we switch over to the annualized QoQ inflation rates, a slightly different story emerges:

So, in this view, inflation bottomed in Q1 and is being driven up by goods inflation this quarter. We see something similar in the recent monthly numbers, and September comes out on Thursday, so we will have a little more clarity then. This is likely due to higher costs from the trade war filtering down to the consumer.

Investment

Outside of IP and inventory investment, there has been little appetite this year:

As expected, there was a bump in residential investment for the first time in over a year. But the declines in the other fixed investment categories are much larger than expected.

The Mystery of Government Spending Inflation Continues

I have been expecting a small upward revision of Q1 real GDP and a small downward revision of Q2 for a while now. I generally have a pretty good eye for anomalous numbers in early prints and where we may expect revisions.

In Q1, we saw a -7.6% QoQ decline in real Federal government nondefense consumption expenditures that was largely driven by a 12.0% inflation rate. In Q2, we saw a 19.4% increase in the same line item, driven by a -9.3% deflation rate. The net for H1 is 12.5% annualized growth in consumption expenditures and a 0.8% inflation rate.

This looks very strange to me. We are seeing big growth in Medicare and Medicaid spending in the nominal tables, but that doesn’t explain the wild swings in inflation. As we’ve seen, large revisions can come many months after a reporting period, so we will have to wait.

Conclusion: Why Did the Sloth Cross the Road?

This report gives more fuel to the thesis that the stimulative effect of the 2017 tax bill had petered out by the end of 2018. At the cost of about $200 billion a year to the Treasury, we are back to 2% growth looking good. Moreover, Ricardian equivalence has done its thing, and corporations have not put the tax cuts into investment, but rather buybacks and retained earnings.

The uncertainty from the trade war is having its effect on investment, but we may also be seeing it trickle down to consumer goods inflation in the past 3-4 months. This is something to keep a very close eye on, because it could produce a situation where the Fed would have to raise rates to combat inflation, even though the neutral rate is telling it to lower rates.

The slow trudge of the sloth across the road looks like the best-case scenario going forward.

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.