Eight days behind schedule—thanks to October’s government shutdown—Q3 GDP was finally released Thursday. Headline growth came in at a 2.8% seasonally adjusted annual rate (SAAR), trouncing expectations ranging from 1.5% to 2.0%. Yet many saw the report as more problematic than positive, focusing on seemingly cherry-picked areas of weakness. Overall, popular opinion seemingly painted the US economic picture a bit darker than reality merits. This doesn’t surprise us: Throughout Q3, sentiment turned more skeptical as folks fell prey to misguided fears—the reaction to today’s GDP numbers is just one example of investors’ unwarranted worries.
Many think GDP rose only because inventories grew, and that’s bad. According to this theory, consumer spending’s rising just 1.5% SAAR signals weakening demand, making Q3’s restocking unnecessary—and potentially a drag on future GDP if businesses cut down on future production. Businesses also spent less on equipment in Q3 (-3.7%), and federal expenditures fell, further adding to fears. Most media outlets highlighted few (if any) other data points, too busy bemoaning businesses’ futures.
In doing so, they overlooked a lot—both in terms of data and the implications of some of the figures they did highlight. Take inventories. Firms likely consider more than just one quarter’s results when planning production and investment. Longer-term trends in earnings, sales and savings, to name a few, may also cross their minds. Moreover, even with the rise, inventories aren’t exactly piling up—stockpiles have been overall lean in recent quarters. This hardly makes increased restocking seem like out-of-the-ordinary business activity. Plus, Black Friday is on its way—maybe businesses are building bigger stockpiles anticipating robust holiday demand! Whether rising inventories are a positive or negative is rarely clear without the benefit of hindsight.
Also ignored: Inventories weren’t even the biggest contributor to growth! Private investment nabbed that honor—despite the widely discussed drop in equipment (think computers and the like) spending. Businesses’ structural investment also grew a fair amount (+12.3% SAAR). Durable goods came in strong, too (+7.8%). Ask yourself: Would big-ticket spending grow so quickly if demand were falling? If the economy were truly weakening, businesses and individuals likely wouldn’t be able to invest in big capital expenditures, even if they spent less on everyday items—they’d scrimp and save across the board.
Exhibit 1: GDP and Its Underlying Components
Source: Bureau of Economic Analysis, as of 11/7/2013.
Many also fret the slow growth in government spending. Which seems a touch odd, considering government spending fell in 12 of 17 quarters, while the economy still grew! The private sector—80% of the whole economy—has more than offset the government drag. Partly because the government’s cutting back created an opportunity for private firms to grow—they stepped up to the job, and the economy continued increasing. The private sector has grown at a pretty healthy clip throughout this expansion—it’s just masked by the government’s impact on headline GDP.
In this sour sentiment environment, however, few sources will describe even solid private sector growth as anything better than “cautionary.” Good news being interpreted as bad isn’t a new phenomenon. Other recent examples include the deficit’s decrease and stocks at all-time highs. Q3 GDP just further illustrates the length folks are willing to go to justify their negative economic view.
In the wacky world of stocks, that’s bullish! The more skeptical investors are in a healthy and improving economic environment, the more fodder for stocks to climb the proverbial “wall of worry.” Plus, the bigger and longer the disconnect between dour sentiment and good data, the more positive surprise power for markets in the end. When investors eventually recognize reality is much better than their expectations, they’ll become willing to pay more for future earnings, boosting stocks. That widespread sour, dour sentiment is still lingering four and a half years into this bull market suggests plenty of time remains for investors to capitalize on (big in our view) future gains.