This morning's positive-looking GDP report will likely add to
the overall positive backdrop created by growing hopes that the
European Central Bank (ECB) will start playing a more active role
in propping up the beleaguered Spanish (and Italian) government
That said, the 'headline' GDP beat should not distract us from
worrisome signs of weakness in the report's internals. Importantly,
the GDP report is not QE-friendly, as it gives QE opponents on the
FOMC enough ammunition to stop Bernanke from doing more, even if he
In its first read on the second quarter of 2012, the Commerce
Department reported that the U.S. economy expanded at a better than
expected 1.5% pace, down from the first quarter's 2% growth rate
(revised upwards from the original 1.9% rate). While 'headline'
growth rate and some key aspects of the report's internals came in
better than expected, they nevertheless represent a decelerating
trend in the economy's growth profile.
Personal consumption expenditures (PCE), or consumer spending,
which accounts for close to 70% of the economy, increased by 1.5%,
compared to the 2.4% increase in the first quarter. Households
spent less on durables, which dropped 1% after the strong 11.5%
growth in the first quarter. Spending on non-durables modestly
declined (1.5% vs. 1.6%), while spending on services (a much bigger
piece of consumer spending) increased from 1.3% in the first
quarter to 1.9% in the second quarter.
The pace of investment growth also decelerated, with
non-residential fixed investment increasing at 5.3% vs. 7.5% in the
first quarter. Non-residential structures barely increased (up 0.9%
vs. the 12.9% increase in the first quarter), while outlays on
equipment and software increased at a 7.2% pace compared to the
first quarter's 5.4% rate. Residential fixed investment decelerated
from the first quarter's 20.5% pace to 9.7%.
Federal government spending dropped, but at a much lower pace than
was the case in the first quarter (down 0.4% vs.4.2%), while
spending by state and local governments also dropped at a modestly
lower rate (down 2.1% vs. down 2.2%). Net exports were a relatively
bigger drag compared to the first quarter, while inventories were a
net contributor instead of a drag as in the first quarter. Final
sales of domestic product, which is basically GDP excluding
inventories, increased at 1.2% rate in the second quarter, half of
the first quarter's 2.4% pace.
Today's second quarter GDP report is not materially different
from the same report a year ago that showed a roughly similar
growth pace in the second quarter of 2011. We all know that the
economy accelerated from that point onwards and ended the year at a
solid 3% growth pace in the fourth quarter. Many are likely hoping
for a repeat of that performance this year as well, reflected in
the +2% consensus growth expectation for the third quarter and
But we should keep in mind that last year's Q2 GDP print
followed a much slower growth pace in the first quarter. This
morning's GDP report and a host of other economic readings
are pointing to the opposite trend relative to what last
year's Q2 GDP report represented - the economy is decelerating
instead of accelerating.
The international backdrop may not be much different from what
the U.S. economy endured last year, though one has to say that the
key emerging markets are clearly slowing down and that Europe may
have reached a critical phase in its long running drama. But more
significant is the unsettled domestic backdrop, with uncertainties
about fiscal policy resulting from the Fiscal Cliff expected to
shave off approximately half a percentage point from GDP growth.
As such, it is perhaps reasonable to be skeptical of current
consensus expectations for second half economic growth. Given the
tone of recent economic reports, I would expect GDP growth
expectations for the second half to be trending lower in the coming
days and weeks. With earnings expectations already coming down, it
is hard to envision stocks making much headway in a decelerating
GDP backdrop, notwithstanding Draghi inspired optimism.
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