US Q4 2014 GDP was revised for a third time Friday, with headline growth remaining unchanged at 2.2% (seasonally adjusted annual rate). Consumer spending was revised up a tad, to 4.4% from 4.2%, but this was basically offset by a slight downward revision in business investment (from 4.8% to 4.7%). If you care to read through all the gory details of the revision, click here. But we are betting that if you are like most media types, you won't click because this revision is the economic equivalent of a yawn.[i] To the extent analysts are discussing Q4 2014’s revision, most focus on a drop in the Bureau of Economic Analysis’ broad measure of corporate profits and project this forward. That forward part is the key—most analysts seem to have already turned the page and are talking down growth in Q1 2015. These lowered expectations are being reported as a threat, but this is overwrought—in our view, lower expectations set up positive surprises, the sort that drive bull markets.
Here are some takes on Q1. The first sentence of The Wall Street Journal’s coverage, for example, is this: “The U.S. economy slowed in the final months of 2014 and corporate profits fell, putting the growth trajectory on a lower path ahead of an apparent slowdown early this year.”[ii] (Boldface is ours, they didn’t do that.) Bloomberg noted, “The rate of economic growth will prove hard to replicate this quarter as harsh winter weather, a stronger dollar, a port slowdown and a global oil glut translate into disappointing spending on the part of consumers and businesses.” Some cite obscure gauges like the Atlanta Fed’s GDP “Nowcast,” a compilation of various monthly data points that attempts to presage what the next quarter’s GDP report will be, and that is asserting growth will be a paltry 0.2% in Q1. (The Atlanta Fed notes this gauge is an average of just over 1.2 percentage points wide of the mark at this point in a quarter.)
Let’s presume these forecasts hold and GDP slows in Q1. What’s that mean for stocks? The answer: Very little. You see, two of the main factors that have weighed on some data releases thus far in 2015 were a West Coast Port labor dispute and a really snowy, cold winter in America’s Northeast. The former likely created a backlog of goods piling up in Portland, LA, Seattle/Tacoma and other major import/export terminals, but it is over, with a new five-year deal inked in February. This likely pushes some economic activity to Q2, but it doesn’t eliminate it. The winter is also over, except maybe in Boston, where The Weather Channel is projecting roughly another inch of fluffy white stuff on Saturday.[iii] It is unlikely cold weather skews data come June, but hey, you never know.
The one major skew many cite that isn’t a one-time event is the stronger dollar. Some suggest the stronger dollar is not only going to weigh down US economic data, but also S&P 500 corporate earnings at multinationals, and many presume this will roil stocks. In our view, though, this discounts the impact of globalization—virtually all major exported final products contain some imported content. The stronger dollar makes these costs cheaper, which mitigates the rising dollar’s impact on firms’ bottom lines.
But also, this is a very widely known factor! Currency markets are neither more nor less efficient and forward-looking than stocks. Presuming the strong dollar will surprisingly hurt foreign-sourced revenues and hammer stocks presumes equity investors will be sideswiped by a factoid hogging media attention for the better part of six months. (Heck, this is why we wrote an entire research report on it. Get your copy here!) For example, according to FactSet, S&P 500 earnings are expected to drop -4.8% y/y in Q1. Now, this is mostly due to Energy, expected to see a whopping -55% earnings drop in Q1, but it isn’t exclusive to that. Firms with a majority of earnings and revenues sourced abroad are expected to be weak, too.
With those expectations in place, positive earnings surprise is easier to attain. And that gap is what moves stocks most! It isn’t all about what results do, it’s how those results mesh with expectations. This is why profits can and do slow—even occasionally falling—amid big bull markets. Amid a strong dollar, S&P 500 profits grew less than 2% in every quarter from Q2 1997 – Q4 1998, falling twice. Stocks rose big, led by US multinationals.
Same song, second verse with GDP. By the time Q1 GDP comes out, we will be nearly one month into Q2, and stocks will be looking even further ahead—not backward. Rather than overthinking any potential wobbles, we suggest looking forward along with stocks, at gauges like The Conference Board’s Leading Economic Index. It’s high and rising, having notched its 12th gain in 14 months in February. Considering no recession in LEI’s 55-year published history has begun during an LEI uptrend, that’s a good sign fears of the expansion’s fragility are greatly exaggerated.
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[i] Except less contagious.
[ii] Growth is not subject to the laws of physics either, so it has no trajectory. Which could be an article, but it has no place in this one. Hence the footnote.
[iii] We assume it will eventually end there, too.