Third Quarter GDP Shows Slowing Growth
Last week, the Commerce Department’s Bureau of Economic Analysis (BEA) released the initial estimate of third quarter gross domestic product (GDP), and the numbers show a significant decrease in economic growth. The US economy grew at a lackluster 1.5% pace, down from 3.9% in the second quarter. Yet many economists are relatively upbeat about the fourth quarter of 2015 and beyond. How does such optimism reconcile with slower growth?
In this case, optimism is partially an artifact of lower expectations. Lower third-quarter growth was expected based on other factors such as the strong dollar and concerns about the slowing worldwide economy. Analysts had predicted a 1.7% growth rate.
Assuming the first estimate holds — which it rarely does — growth through the first three quarters averaged 2.0%. The average growth from 2012 through 2014 was 2.1%, so we are essentially on the same slow growth track that we have been on for years. While that is not the best news, it is also nothing to be apprehensive about.
The other main reason for optimism lies a little deeper in the numbers, and what components of GDP are traveling in which direction.
Inventories versus Spending
Inventories led the downward pull on GDP. Private inventory investment sank as businesses cleared out their overstocked shelves and reduced orders for manufactured goods. International trade had a limited impact on inventory and GDP, as a 1.9% increase in exports was basically neutralized by a 1.8% increase in imports.
The Wall Street Journal pointed out that if the inventory figures were removed from the third-quarter GDP the value would almost double to a healthier 2.9%. It is not uncommon for inventory-driven drops in GDP to be followed by rising numbers for a simple reason — businesses cleared their shelves as expected, and are ready to order replacement products, driving manufacturing output higher.
That analysis assumes that spending continues at a decent pace in order to pull manufacturing outputs all the way through the system. On a global scale, spending may be slowing, but domestic consumer spending has remained solid. Personal consumption expenditures (PCE) rose by 2.19%, neutralizing the effect of the sharp inventory drop and then some. Subtract PCE from the GDP and the GDP contracts by almost 0.7%.
It's not a given that spending will continue in this fashion. PCE did drop a bit in the third quarter from the second quarter's 2.42% growth rate, and durable goods orders fell 1.2% in September while August's contraction was increased to 3.0%. Meanwhile, the measures of consumer confidence are mixed but mildly optimistic. The Consumer Confidence Index dropped a bit to 97.6 — lower than it has been recently but still in relatively good shape — while the University of Michigan Consumer Sentiment survey index rose to 90.0 from September's 87.2 reading.
Heading into a holiday spending season with at least mildly optimistic consumer spending indicators suggests that the fourth quarter may well provide a rebound, assuming the worldwide economic situation does not deteriorate any further.
Other Positive Signs
Other data suggests reasons for mild optimism as well. Housing still has some issues, especially with the supply of affordable starter homes, but overall, it has been a bright spot in 2015.
Residential investment in the third quarter was up by 8.9% year-over-year, which is the best mark in two years. That news was tempered somewhat by a slump in new home sales and pending home sales, but existing home sales rose significantly.
Global growth and concerns about China have settled down from the summertime anxieties, and while growth is likely to be slower for some time, the fears about the bottom falling out of China's economy have calmed somewhat.
The BEA report noted that real disposable personal income increased by 3.5% in the third quarter compared to 1.2% in the second quarter. At the same time, the personal saving rate rose slightly to 4.7%. In other words, people have more money, are saving a bit of it, and are spending significant amounts of it based on the PCE values. That's further reason for fourth quarter optimism.
The Effect on the Fed
No discussion of GDP changes would be complete without the typical "will they or won't they" debate regarding the Fed and raising interest rates. During their October meeting, the Fed made it clear that it would consider an interest rate rise in December. Regardless of what happens in December, interest rates will begin to rise soon enough — but the market has likely priced in the effect of any small rate increase that does occur.
Mesirow Financial Chief Economist Diane Swonk suggested that the Friday releases such as the employment cost index (ECI) would have more effect on the Fed than the GDP numbers. That's because the ECI effectively measures all costs for businesses of employee compensation and thus is an indicator that wages and benefits are rising as businesses try to attract new employees or retain their existing ones. The ECI readings showed a 0.6% increase quarterly and a 2% rise year-over-year, blending in nicely with the concept of cautious optimism.
In short, the GDP numbers are only one part of the overall context of Fed-watching and analysis. Don't let the phrase "growth stalls in third quarter" fool you.
Some analysts are looking at the third quarter GDP drop as evidence of a further economic slowdown, but to us it looks like a continuation of the same old story. Growth is slow and it's likely to stay slow and steady for some time with monthly fluctuations around that growth rate.
Keep that in context as you evaluate what to do with your investments and assets. A single quarter's GDP or its revision has to be taken in the context of trends and overall economic information. Your investments have more to do with whether your individual stocks are overvalued or undervalued, and how the individual companies are performing — so you should probably focus more on the earnings reports of the companies you hold instead of the broader US growth picture. With respect to your individual portfolio, there's more actionable information in earnings reports than there is in BEA press releases.