Robust Growth Continues

Economic growth continued at a robust rate in the third quarter, supporting the case for both a continued bull market in stocks and further rate hikes from the Fed.

While we might make minor adjustments when we get Thursday's data on durable goods, international trade, and inventories, right now our model forecasts real GDP expanded at a 3.6% annual rate in Q3. If so, the real economy grew at a 3.1% pace in the past year, a roughly 50% acceleration from the 2.1% growth rate that defined the Plow Horse Economy from mid-2009 through early 2017. It's clear that cutting tax rates and slashing red tape have boosted economic growth. And there is room to run. We don't see a recession coming for at least the next two years, and potentially much longer.

But that won't stop the pessimists, who are likely to assert that inventories artificially boosted Q3 growth. Yes, it's true that the pace of inventory accumulation was fast, but that simply makes up for the unusually large drop in inventories in the second quarter. A similar story holds true for net exports, which will be an unusually large drag on growth in Q3 after pushing growth higher in Q2. In other words, inventories and trade are just swapping the roles they played in Q2.

Here's how we get to our 3.6% real growth forecast:

Consumption: Automakers reported car and light truck sales declined at a 4.8% annual rate in Q3. Meanwhile, "real" (inflation-adjusted) retail sales outside the auto sector grew at a 4.4% annual rate. Most consumer spending is on services, however, and real service spending looks like it climbed at about a 3.0% annual rate. Putting it all together, it looks like real personal consumption (goods and services combined), grew at a 3.1% annual rate, contributing 2.1 points to the real GDP growth rate (3.1 times the consumption share of GDP, which is 68%, equals 2.1).

Business Investment: Another quarter of solid growth in business investment, with our estimates showing equipment growing at an 8.5% annual rate, commercial construction growing at a 3% rate, and intellectual property growing at a 4.5% pace. That would mean total business investment grew at a 6.0% rate in Q3, which should add 0.8 points to real GDP growth. (6.0 times the 14% business investment share of GDP equals 0.8).