Orlando's Outlook: Economy lifts out of temporary soft patch
Bottom line This morning’s advanced report for third-quarter Gross Domestic Product (GDP) of 2.0% was slightly stronger than expected (1.8% consensus), due to solid consumer spending, continued momentum in housing, and a surprising surge in government defense spending. On the negative side of the ledger, business fixed investment turned negative, inventories slipped due to the farm drought, and net exports declined because of weak foreign demand. The good news is that this Commerce Department report likely confirms our temporary economic soft-patch thesis, as growth had slowed from 4.1% in last year’s fourth quarter to 2.0% in this year’s first quarter, and to 1.3% in the second quarter, which we still believe will serve as this year’s trough. But the bad news is that at 2.0%, GDP growth is still anemic, below the economy’s trend-line growth rate of 3.0%, and well below the 4.0% rate at which we believe the economy should be operating right now. To that point, this will be the last reading on GDP growth before the critical Nov. 6 election in less than a fortnight, so there are important political implications associated with this subtrend GDP report and Washington’s suboptimal fiscal policies that contributed to it. Moreover, if our newly elected officials—whoever they may be—are unable to work across the aisle and collaboratively defuse this ticking fiscal-cliff time bomb, we do not believe that the U.S. economy is sufficiently robust to absorb such a negative growth shock, which significantly increases the odds of a recession next year.
Here are the key details regarding today’s third-quarter GDP flash report:
Consumer spending improves Personal consumption expenditures, which account for 70% of GDP, rose by 2.0% in the third quarter, which added 1.4 percentage points to GDP. This compares with only 1.5% growth in the second quarter—the slowest pace in a year—and with gains of 2.4% in consumer spending in the first quarter and 2.0% in the fourth quarter of 2011. As we discussed in our note last week, Back-to-School (BTS) sales in the third quarter were pretty good, compared with negative retail-sales results during April, May and June—the longest sequential period of decline since 2008. But the consumer bright spot in the third quarter was durable-goods sales, which leapt by 8.5%, versus a 0.2% decline in the second quarter, boosted by a strong rebound in auto sales, which are now running at an annualized run rate of just under 15 million units, a four-and-a-half-year high. The personal savings rate fell in the third quarter from 4.0% from 3.7%, which helped to fuel stronger consumption trends.
Housing accelerates Marking its sixth consecutive quarterly gain, residential investment leapt by 14.4% in the third quarter, adding 0.3 percentage points to GDP, compared with an 8.5% second-quarter increase, a robust surge of 20.5% in the first quarter, and a 12.1% gain in last year’s fourth quarter. We remain confident that the housing industry hit bottom a year ago, and its pace of recovery is linked to future gains in employment.
Government spending soars The surprise of this GDP report is that after eight consecutive negative quarters, total government spending actually rose by 3.7%, versus declines of 0.7% in the second quarter, 3.0% in the first quarter and 2.2% in last year’s fourth quarter. Federal defense spending unexpectedly surged by 13.1% in the third quarter, adding 0.6 percentage points to quarterly GDP and marking the first positive reading in a year after declines of 0.2% in the second quarter, 7.1% in the first quarter and 10.6% in last year’s fourth quarter. State and local spending ticked down marginally in the third quarter for their 12th consecutive quarterly decline.
Capex turns negative Real business fixed investment actually fell by 1.3% in the third quarter, compared with a gains of 3.6% in the second quarter, 7.5% in the first quarter, 9.5% in last year’s fourth quarter, and 19.0% in the year-ago quarter. Business equipment and software spending was flat, representing the weakest reading in three years, after gains of 4.8% in the second quarter, 5.4% in the first quarter, 8.8% in the fourth quarter of 2011 and 18.3% in the year-ago quarter. Business structure investment, such as factories and office buildings, fell by 4.4% in the third quarter on the heels of increases of 0.6% in the second quarter, 12.9% in the first quarter, 11.5% in last year’s fourth quarter and a booming 20.7% leap in the year-ago quarter. There’s clearly a negative pattern forming here over the course of the last five quarters due to the economic chilling effect from the impending fiscal cliff. With a complete lack of visibility regarding the election and the fiscal cliff, companies have simply decided not to hire or invest in their businesses in the interim until there is some clarity on how business-friendly Washington’s new fiscal policies will be come January 2013.
Inventories slip The pace of inventory restocking slowed to $34.1 billion in the third quarter, down from $41.4 billion in the second quarter, $56.9 billion in the first quarter and $70.5 billion in last year’s fourth quarter. The worst Midwest drought in half a century had something to do with this trend, as farm inventories would have been $20 billion higher otherwise, which cut 0.4 percentage points from quarterly GDP growth.
Trade slower The sluggish economy here and weaker end-market demand overseas due to slower developed and emerging-market economic growth contributed to a reduction of 0.2 percentage points from third-quarter growth due to a wider trade gap. Exports declined by 1.6% in the third quarter—their first actual drop since the first quarter of 2009—compared with gains of 5.3% in the second quarter, 4.4% in the first quarter and 1.4% during the fourth quarter of 2011. Imports slipped by 0.2% in the third quarter, compared with much more robust gains of 2.8% in the second quarter, 3.1% in the first quarter and 4.9% in last year’s fourth quarter.