KEY DATA: GDP: 3.5%; Consumption: 4.0%; Fixed Investment: -0.3%; Prices: 1.6%/ Sentiment: -1.5 points
IN A NUTSHELL: “The headline says strong growth but there are warnings in the details.”
WHAT IT MEANS: The economy grew really solidly in the summer. The headline number pretty much matched economists’ expectations. But if you look at the individual components, there are some concerns. First, almost sixty percent of the increase came from inventory building. Firms have been adding to stocks to support their strong sales, but the inventory build added over two percentage points to growth, which is greater than expected and clearly not sustainable. This is just the first estimate of GDP and I would not be surprised if the inventory number was revised. The consumer also spent money like crazy, buying everything that moved or didn’t. But the gain was also above expectations and it too is not likely sustainable. Over the past two quarters, disposable income increased at a 2.5% pace while spending soared at a roughly 3.75% rate. Again, something has to give. As for the business sector, except for filling up warehouses, firms did little investing in structures or equipment. They did buy lots of software (intellectual property), but business fixed investment overall was a drag. If we were going to see massive capital spending, we should have started to see it already. We haven’t. As for the trade deficit, it widened sharply as exports declined while imports surged. So much for tariffs turning things around. One bright spot was government spending. Government purchases added over one-half percentage point to growth. It is good to see that our politicians at all levels are now embracing Keynesian economics and have opened the spigot wide. Despite the strong growth, consumer prices rose at the slowest pace in a year. The rate was well below expectations as the costs of both durable and nondurable goods fell, at least that is what the government claims. Services inflation remained fairly high.
The University of Michigan’s Consumer Sentiment Index eased a touch in October. However, the level remains extremely high, indicating that households have not been affected significantly by either rising rates, rising inflation or rising political rhetoric.
MARKETS AND FED POLICY IMPLICATIONS: When we got the second quarter number, I suggested that it could be the high water mark for this expansion. It is looking more and more like it will be. Household incomes are just not expanding fast enough to sustain the rapid spending paces posted in the second and third quarters. Businesses are showing few signs of spending heavily on plants or equipment. Indeed, in yesterday’s durable goods report, the proxy for business investment declined for the second consecutive month. Firms are doing what they are supposed to do, regardless of tax cuts: They are looking into the future and deciding if spending large amounts of funds on major projects will pay off. It appears most business leaders have become somewhat cautious about the future and are holding off committing to major investment plans. That is what many economists feared and a point I have made for this entire year. As for the trade situation, how many times economists have warned that anything with war in it cannot be good, I don’t know, but the trade battles have not made things better. So, all we have to fall back on is expansionary fiscal policy. I will not point out the obvious irony of a government run by Republicans depending on heavily on government spending for growth. Oh, yes, I just pointed that out. So, don’t expect fourth quarter growth to be anywhere near what we have seen over the past two quarters. The economy is not faltering, it’s just that we are moving back toward more sustainable growth.