Fisher Investments Editorial Staff
GDP

No Devil in These Details

By, 12/06/2013
Ratings594.067797

“Not all good news,” “no momentum” or “less than meets the eye” are just a few sample interpretations of Q3’s upward GDP revision released Thursday. Only one of nine economists quoted here by The Wall Street Journal had nothing bad to say about Q3 GDP’s beating the preliminary estimate—and most headlines were with the other eight. Yet these reactions don’t necessarily reflect reality. A better indication, in our view, is the many more recent signs of continued growth in the US and worldwide. These suggest continued good surprises are in store for stocks.

Q3 GDP’s upward revision to a 3.6% seasonally adjusted annualized rate (SAAR) crushed its previous estimate of 2.8% growth. But, never satisfied with simple good news, many looked to see if there was a catch. What did they find? Inventories’ contribution doubled (from adding 0.8 percentage point, or ppt, to 1.68), while consumer spending rose less than expected (revised down to 1.4% growth versus 1.5%). As a result, the media meme developed that Q3’s inventories rose because shoppers didn’t clear businesses’ shelves fast enough—a dour, and likely misleading, interpretation.

Underlying data show the economy would have grown with or without inventories’ contribution. Plus, rising inventories doesn’t automatically mean unsold, unwanted goods are clogging retailers’ shelves. It might mean businesses expect higher sales (say, increased holiday season demand), which implies higher spending and future restocking—good for future growth.

Bigger inventories don’t mean growth has to slow the next quarter—even if inventories fall off in Q4, growth can continue. In 2010, for example, GDP grew 2.8% in Q3, with inventories contributing 1.9 ppts—and grew 2.8% again in Q4 even though falling inventories detracted -1.64 ppts. No one variable makes or breaks the entire economy. How the economy grows from here will depend on how consumers spend, businesses invest, factories produce and the like. Q3 GDP data don’t give you a good read on this. Finally, the report covers data from July through September—data two to five months old. This says nothing of economic conditions moving forward.

More recent data paint a better picture and should help put to rest the common fear Q4 GDP must disappoint. Like higher trade in October: Exports were up +1.8% m/m (+5.5% y/y), and imports rose +0.4% m/m (+3.6% y/y). Demand is growing at home, and producers are capitalizing on higher demand abroad. Businesses’ borrowing hit a six-year high in October—fodder for future capex—and new home sales hit a 33-year high the same month. Per Institute of Supply Management surveys, US manufacturing (57.3) and services (53.9) also grew in November (readings over 50 indicate expansion). Manufacturing was once again led by the very forward-looking new orders index, which rose to 63.6. Order backlogs jumped 2.5 pts to 54—US manufacturers have more demand than they can keep up with. This implies a pick-up in production even with inventories a bit fuller. US services new orders (56.4) are also above the headline print, with new export orders a robust 58.0. It’s all evidence demand is much stronger than Q3’s GDP handwringing would indicate.

Strong economic expansion isn’t unique to the US—global data are heating up, too. The UK recovery surged on in November with the construction PMI rising to 62.2 (primarily on housing), services hitting 60 and manufacturing at 58.4. Services’ and manufacturing’s new orders sub-indexes clocked in at 63.1 and 64.6, respectively—Britain is gaining steam. Other areas are improving, too. The eurozone continued recovering (albeit unevenly) in November as manufacturing expanded for a fifth month (51.6), led by a strong Germany (52.7), and services grew (51.2). Chinese manufacturing also rose in November (51.4), and services expanded at 52.5. Overall, global manufacturing (53.2) and new orders (54.3) remain strong, as they hit their 11th and 14th months of consecutive growth in November.

Most Leading Economic Indexes (LEI) are rising, too, further suggesting the global expansion is poised to continue. LEI, though not perfect, is a pretty reliable gauge of an economy’s future direction. Components vary from country to country, but in general, each LEI aggregates a handful of mostly forward-looking variables. In the US, no recession in the last 50 years has been preceded by a rising LEI trend—recessions usually don’t happen until LEI has fallen for some time. The rate spread is a key LEI component in the US, UK and eurozone, and wider spreads have boosted all three in recent months. Rate spreads should widen further after the US ends quantitative easing, giving the global economy more fuel.

Few expect reality to be this good—sentiment remains quite guarded. Stocks tend to move on this gap between expectations and reality—the wider it is, the higher they can climb. When investors begin realizing things are better than they feared and their outlook starts improving, stocks should rise even more. Confident investors are willing to pay more for future returns.

So we say, let the economists fret over the finer points of Q3’s better-than-expected GDP figure. Looking at the bigger picture, the global expansion is strong and likely to continue. That most folks expect otherwise means there is plenty of room left for investors’ confidence to increase and for stocks to rise with it.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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