The Independent Market Observer

Strong GDP Report: Treat or Trick?

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Oct 28, 2016 12:44:20 PM

and tagged In the News

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economyThis is the season of ghosts and goblins, scary monsters, and small children roaming around in packs to loot the neighborhood of candy. In other words, it’s very much like the typical investment environment, with everyone looking to get something sweet but nervous about what might leap out of the bushes.

Case in point: this morning’s big economic news. With investors hoping for a treat but fearing a trick, the release of the first estimate of third-quarter GDP growth was a positive surprise. Economic growth came in at 2.9 percent, well above expectations of 2.5 percent and more than double the growth of 1.4 percent we saw in the second quarter. 

A positive report, but the devil’s in the details

First things first: this is a strong report and certainly shows that the slowdown over the past couple of quarters has not killed the recovery. In fact, it confirms that the recent slowdown was likely just that and not something worse. Combined with all of the other improving factors, it looks as if we’re moving back into a faster growth mode.

That's good news, without a doubt, but the details aren’t quite as solid as the headline would suggest.The upside surprise came largely from two elements: a 10-percent increase in exports and an increase in inventories. Combined, those two factors added 1.4 percent. Without them, growth was actually around 1.5 percent—in line with the previous two quarters, which suggests it hasn't accelerated after all.

Exports and inventory growth will be key

Which story is true? It depends on whether exports and inventory growth can continue at the current pace.

For exports, the answer is quite possibly yes. Although a big part of the surge was due to a spike in soybean exports, which is likely to be reversed, the overall increase is evidence that the strong dollar is no longer a headwind for exporters. With U.S. businesses now competitive on a currency basis, any decline in the dollar should be helpful.

For inventories, the substantial bump this quarter was actually payback for the past five quarters, when inventories were a drag on growth. Therefore, we may well get another quarter or two of rebound, and after that, inventories would simply be normalized. On balance, another positive development.

Apart from these two items, however, the news was not as good. Consumption growth was down to 2.1 percent, which is probably a reasonable baseline for where growth would be absent exports and inventories. Residential construction was down as well. Investment in energy has bounced back, however, which matters, as it has been a serious drag over past quarters as well.

All things considered, more treat than trick

Although monsters are potentially lurking in the bushes here, overall, today's GDP report is considerably more treat than trick. Strong top-line growth, recovery in inventory spending, and strong export growth are all solid tailwinds for the rest of the year.

Relatively weak consumer and business spending growth can reasonably be attributed to lingering effects from the economic slowdown of the first half of the year and even to the incredibly negative environment of the election season. With both consumer and business sentiment up, any recovery in those components would drive further improvements in growth.

Looking to the future, it seems likely that GDP growth will move back to between 2 percent and 2.5 percent over the next couple of quarters, which would certainly be a treat. Not the full-size Snickers bar, perhaps, but at least a small Baby Ruth. And after a couple of quarters of getting toothbrushes in the goody bag, that doesn’t sound bad at all.

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