US Equity And Economic Review: Moderate Growth and Declining Earnings, Edition

The BEA issued its second GDP report last week, increasing the 3Q GDP estimate to 2.1%. Real gross domestic purchases – a measure of strictly domestic demand – increased 2.8% Y/Y. From the report:

The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), nonresidential fixed investment, state and local government spending, residential fixed investment, and exports that were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, increased.

Consumer spending was strong: durable goods were up 4.8% Q/Q while service expenditures increased 4%. Fixed investment declined, but largely as a result of a 7.1% drop in commercial real estate investment. Capital expenditures rose 9.5%. And imports (a net drag on growth) increased 2.1% while exports declined .9%.

Doug Short notes the tight relationship between PCEs and GDP:

Over the time frame of this chart, the Personal Consumption Expenditures (PCE) component has shown the most consistent correlation with real GDP itself. When PCE has been positive, GDP has usually been positive, and vice versa. In the latest GDP data, the contribution of PCE came at 2.05 of the 2.08 real GDP. This is down from the 2.42 of Q2

He offers the following chart:

There have been a number of one-off GDP events this expansion. For example, bad winter weather negatively impact 1Q14 and 1Q15; Washington gridlock lowered growth on several others. And now the industrial recession caused by weak oil prices, the strong dollar and weaker overseas economies is taking a bit off top-line numbers. Thankfully, domestic demand continues to rise.

The BEA also reported disposable income this week:

Personal income increased $68.1 billion, or 0.4 percent, and disposable personal income (DPI) increased $56.8 billion, or 0.4 percent, in October, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $15.2 billion, or 0.1 percent. In September, personal income increased $27.4 billion, or 0.2 percent, DPI increased $27.0 billion, or 0.2 percent, and PCE increased $9.5 billion, or 0.1 percent, based on revised estimates.

This table from the report shows the real numbers both DPI and expenditures increased this quarter:

However, note that consumers continue to be a bit cautious with expenditures; spending is still below DPI. That naturally transitions to this chart of the personal savings rate, which has fluctuated around 5% since the recession’s end:

This high level of savings indicates a fundamental shift in U.S. consumer behavior.

The Census Bureau reported an increase in durable goods orders:

New orders for manufactured durable goods in October increased $6.9 billion or 3.0 percent to $239.0 billion, the U.S. Census Bureau announced today. This increase, up following two consecutive monthly decreases, followed a 0.8 percent September decrease. Excluding transportation, new orders increased 0.5 percent. Excluding defense, new orders increased 3.2 percent.

The monthly vacillations are meaningless until the number moves above the 240,000 million level. That level has provided strong resistance since halfway through 2013:

Finally, existing home sales fell 3.4%. This graph from Calculated Risk shows the current sales pace is slightly above the peak level of the 1990s expansion:

Additionally, inventory is very low (top chart) and is currently declining (bottom chart):

The Atlanta Fed’s GDPnow forecast dropped this week, projecting 4Q growth of 1.8%. Moody’s also dropped this week; theirs fell to 1.7%. The Cleveland Fed’s yield curve GDP predicts 4 quarter growth of 1.9%. The Atlanta Fed’s Recession Index remains at the low level of 13.3%

Economic Conclusion: the shallow industrial recession continues. There is no reason to think this trend will stop anytime soon. China is slowing, leading to weaker emerging economies. And the dollar will continue to be strong so long as the Fed is poised to raise rates. But sufficient domestic demand remains to keep the US economy growing “moderately.”

A Look at the Market: The market is expensive. The current and forward PEs on the SPYs and QQQs is 23.18/23.25 and 17.55/20.10, respectively. Perhaps more importantly, corporate profits are getting weaker. From my co-blogger, New Deal Democrat:

Now let's look at corporate profits and stock prices in absolute terms. The following graph norms corporate profits (blue), as well as stock prices (red), to 100 as of the last peak, Q4 2007. Since the beginning of 2012, corporate profits have only risen a little over 10%, while the S&P index shot up by more than 50%, becoming as fully valued as just before the last recession this year:

And, thanks to a strong dollar, weak energy sector and slowing emerging economies, corporate profits for the S&P 500 are declining. From Bloomberg:

Profits from S&P 500 companies have fallen by about $25 billion in the first three quarters of this year, and a further drop is expected before the end of 2015 as energy companies battle with lower oil prices and a sharp rally in the dollar hits exporters.

This discussion of corporate profits leads nicely to this weekly chart of the SPYs:

For all of 2015, the technical level of 2012-2014 has provided strong resistance to all upside moves. The lack of earnings growth explains the lack of upside momentum: with the market already expensive there is little reason to continue bidding stocks higher. And the declining earnings environment adds fuel to the bears’ arguments. It still remains difficult to see the market advancing beyond previous highs until earnings growth accelerates.

© Hale Stewart

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