Just Plowing Ahead

On October 23rd, 2014, posted in: Economic News, Newsletter by

It has been a while since Wealth Teams sent out a newsletter. There has been little to report. But with the recent decline in the market, it seems like a good time to look at the year in review and to consider what lies ahead.

This recovery started in mid-2009. Since then, real GDP has grown at a 2.2% annual rate (referred to as a Plow Horse Economy), and even though the first quarter was negative, (caused by weather and inventory declines), the economy is picking up some speed. It is not a race horse, yet, but GDP is expected to hit 2.5% to 3% real growth, on average, in the 12 months.

For those libertarians among us, the main reason for faster growth is government spending has declined as a percent of GDP. No one will give the GOP credit for this, but they forced the reduction in spending to the howls of the opposition party. Government spending is down to 20.3% of GDP in Fiscal Year 2014 (due to increased tax revenue). This is the lowest since 2008, and down substantially from the peak of 24.4% in 2009. The government is still a drag on the economy, but just less of one. The Sequester (now 50% of the highpoint), an end to extended unemployment benefits, and tapering by the Fed are all signals the tide may be turning.

Smaller government means a bigger and more vibrant private sector as a percentage of GDP. The unemployment rate fell to 5.9% last month and initial claims for jobless benefits plummeted to 264,000 last week, the lowest since 2000. This does not include those not looking for work which pushes the rate up to almost 11%. But even so, the labor market is still far from its full potential. Layoffs are few and far between.

You have probably read the continual stream of Ebola stories and dire predictions. Perhaps it is a Black Swan in the making. Not being a physician or expert on pandemics, just recall these facts. Thomas Duncan, the Liberian patient who passed away in Dallas, was admitted into a Dallas hospital on September 28th. Since then, the only domestically-contracted cases of Ebola have been reported – both were nurses who had immediate medical contact with Mr. Duncan. No one else has contracted it – not his family, nor those who rode on the plane with him, or anyone else whom he met while in the US. This may not be the crisis the media has proclaimed.

As for the fundamentals next week the government reports on real GDP for the third quarter. After a 4.6% growth rate in Q2, expect real GDP to rise at a 2.9% annual growth rate in Q3.

Here are some snapshots for Q3.

Consumption: Auto sales increased at a 6% annual rate in Q3 and “real” (inflation-adjusted) retail sales outside the auto sector grew at a 2% rate. Services make up about 2/3 of personal consumption and those appear to be up at about a 1% rate. As a result, it looks like real personal consumption of goods and services combined, grew at a 1.9% annual rate in Q3, contributing 1.3 points to the real GDP growth rate (1.9 times the consumption share of GDP, which is 68%, equals 1.3).

Business Investment: Business equipment investment looks like it grew 12% at an annual rate in Q3. Commercial construction looks like it grew at a healthy 3.4% rate. Factoring in R&D suggests overall business investment grew at a 7% rate, which should add 0.9 points to the real GDP growth rate (7.2 times the 13% business investment share of GDP equals 0.9).

Home Building: A 6% annualized gain in home building in Q3 will add about 0.2 points to real GDP (6 times the home building share of GDP, which is 3%, equals 0.2).

Government: Public construction projects, which had been slowed by the weather in Q1 and rebounded sharply in Q2, continued to increase in Q3. In addition, military spending grew at its fastest pace since 2008 during the third quarter. As a result, it looks like real government purchases grew at a 1.6% annual rate in Q3, which should add 0.3 percentage points to real GDP growth (1.6 times the government purchase share of GDP, which is 18%, equals 0.3).

Trade: At this point, the government only has trade data through August, but what it does have looks very good for US GDP. The “real” trade deficit in goods has gotten smaller in Q3. As a result, we’re forecasting that net exports add 1.0 points to the real GDP growth rate.

Inventories: After a weather-related lull in Q1, companies built inventories at a very rapid pace in Q2, correctly anticipating faster economic growth ahead. Now companies are still building inventories, but not at quite the same rapid pace. As a result, it looks like inventories will subtract 0.8 points from the real GDP growth rate in Q3.

It was reported at the end of Q1, the drop in real GDP was a sign the US recovery had stalled. Instead, Q2 shot through the roof, making up for the storm riddled 1Q. It is inevitable this expansion will end, someday. But there is nothing on the horizon to say it is apparent when. Despite tapering, loose monetary policy, and a shrinking government relative to GDP, there is ample room for the private sector to grow. To think this economy is falling off a cliff is just not evident in the numbers. Remember, markets go up and markets go down. The media makes its money from selling predictions. How often have they ever been right, prospectively?



This information is compiled by Guy Baker from an assortment of news feeds including First Trust, Yahoo Finance, Bloomburg and others. This information is intended to be informational only. This newsletter contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Investing involves risk including the potential for loss of principal. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.

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