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Q3 Prints Better Than Expected

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by: J.G. Collins
Summary

There is still no recession in sight.  This morning's print was 30 bps better than expected.

Inventories seem to have burned off, so we'll probably see a build in Q4 2019 that will contribute to GDP.

There was surprising strength in consumer durables, albeit less than last year or last quarter.

The GDP risk is if sectors other than PCE decline substantially to subsume the roughly 2% PCE growth we see through at least mid-2020.

New York (October 30) - Gross Domestic Product growth for the third quarter of 2019, or “2019Q3 GDP,” printed at 1.9%, above the consensus estimate of 1.6% That’s just 10 bps below the final 2.0% reading of the last quarter, but down 100 bps below the comparable period last year.

The 1.9% GDP growth rate is in the higher end of the GDP growth rate we predicted in our last jobs report, where we had anticipated growth. 2019Q3 GDP was led, once again, by Personal Consumption Expenditures, or “PCE,” which printed at 1.93%. The weakest of the four GDP components was Gross Domestic Investment “GDI,” which printed down 27 basis points. Net Exports, or “NEX,” printed down just -8 bps. Government Consumption Expenditures (GCE) increased 35 bps.2019Q3 GDP by Major Segment

The Power Of Consumers

GDI also reduced in the second quarter, but not as much as it had last quarter. Inventories burned off, though, and we look for growth in that element of GDI in 2019Q4. Fixed investment in things like buildings and equipment continued to decline, but slightly less than last quarter.

We anticipate that PCE will continue to drive GDP growth through 2020Q2, as the IBD/TIPP Economic Optimism Index for October climbed to 52.6, following a big drop in June. Debt service as a percentage of disposable income is at among its lowest levels in a decade. The danger to the economy is if we see declines in other segments of GDP (NEX, GCE, GDI) subsume the roughly 2% of PCE growth we see in the foreseeable future.

As stated, 2019Q3 GDP came in toward the higher end of what we anticipated and it exceeded expectations, which was a consensus 1.6%

Short Term

The IBD/TIPP index of Economic Optimism for October climbed to 52.6. The other IBD/TIPP economic indexes, which are based upon surveys by TechnoMetrica Market Intelligence, are similarly moderately optimistic.

Notwithstanding today's rate cut, we would prefer the Fed simply acknowledge its December error and emphasize that today's cuts are mostly attributable to foreign economies instead of talking down an economy that is, given the circumstances performing reasonably well, with average growth at 2% and unemployment at 3.7%. In fact, we would prefer the Fed not decrease rates because of the recent trimmed mean M2 velocity remains fairly flat. If the Fed reduces rates further, we anticipate this will remain flat or even a further decline.

Medium Term

Inflation remains low, seemingly inapposite to the dogma of the Phillips Curve. Likewise, a low interest rate environment, and a low M2 velocity in a medium-growth economy seems contrary to the Quantity Theory. We’re of the view that both of these rules are affected - and possibly made obsolete - by the Fed paying interest on excess reserves, something it had not done prior to 2008. This is because so much of the money produced by Fed Open Market Committee operations is being kept in the banking system, at the Fed, instead of in the regular economy. We’ve never had that before; some older economic theorems may now be consigned to the dustbin.

Long Term

Our long-term view of the economy, beyond 2022Q2, remains unchanged.

Aside from AI, 5G, and electric cars - none of which are fully “ripe” to make a significant impact on the economy, there is really 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.

Growth is coming from what we call soft sectors: personal services like food and product delivery and on-demand taxi and cable TV services, social media, and consumer items. Meanwhile, big industrial firms like Boeing (NYSE:BA) and Caterpillar (NYSE:CAT) - where thousands of people are employed and wages tend to be high - are struggling with technological issues and trade.

President Trump’s more protectionist trade rhetoric could add foreign-owned domestic production to drive GDP growth, particularly in the GDI category. But, so far, that rhetoric has mostly 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 started to ramp up in the last few quarters, notwithstanding trade issues. We anticipate that ratifying the United States-Mexico-Canada Agreement, the “USMCA, will add a couple of basis points to GDI as will a favorable resolution of the China trade talks. The anticipated December UK elections should - finally - provide some certainty on Brexit.

In equities, we’re mostly inclined to stand pat with these sectors from our September jobs summary, with some changes, as follows:

  • Outperform: Trucking and delivery services on speculation of consolidation and acquisition, consumer discretionaries and retail in the higher- and luxury-end segment, higher-end QSRs and casual dining, and REITs that own real estate in sectors identified as "opportunity zones" under the Tax Cut and Jobs Creation Act of 2017. We think CHF is a safe haven from domestic and geopolitical uncertainty.
  • Perform: Consumer discretionaries and retail across in middle-market and low-end sectors; consumer staples, energy, utilities, telecom, and materials and industrials; certain leisure and hospitality; and healthcare; currencies of developing nations, such as INR; and the GBP and EUR.
  • Underperform: Financials; the asset-light hospitality sector on speculation of declining GDP, costs; technology; lower-end, low-quality QSRs (e.g., McDonald's (NYSE:MCD), Domino's Pizza (NYSE:DPZ), YUM! Brands (NYSE:YUM), etc.) on greater US delivery competition and a slowing economy; lower end hospitality on a slowing economy and a decline in consumer confidence.

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Additional disclosure: The views expressed, including the outcome of future events, are the opinions of the firm and its management only as of today, October 30, 2019, and will not be revised for events after this document was submitted to Seeking Alpha editors for publication. Statements herein do not represent, and should not be considered to be, investment advice. You should not use this article for that purpose. This article includes forward looking statements as to future events that may or may not develop as the writer opines. Before making any investment decision you should consult your own investment, business, legal, tax, and financial advisers.