When it comes to measuring the strength of the U.S. economy, the Department of Commerce’s Gross Domestic Product (GDP) report reigns supreme. GDP is the total dollar value of goods and services a nation produces and is the key indicator on the health of our economy. A growing, vibrant economy translates to job growth, rising wages, greater disposable incomes and ultimately, greater corporate profits and rising stock prices.
The latest GDP report serves as the first look at economic growth in the July-September third quarter. In a healthy economy, the expected growth rate should be in the 3-3.5 percent range. However, in the eight years since the 2007-2009 Great Recession, our annual economic growth rate has averaged just 2.175 percent. In the third quarter, the economy grew at an annual rate of 3.5 percent – above the 3.3 percent growth rate the market was expecting but below the second quarter’s exceptional growth rate of 4.2 percent.
Overall, the third quarter GDP report was surprisingly strong given our nation’s concerns over rising inflation, interest rate hikes, trade disputes and a general weakening of the global economy. However, business fixed investment – the big-ticket purchase of factories, equipment and technology – came to a grinding halt, increasing by just 0.8 percent in the third quarter. This was significantly lower than the 11.5 percent and 8.7 percent growth rates reported in the first and second quarters, respectively. So, why was there such a large falloff in business spending?
There is lack of consensus on what exactly drove this decline. One possibility is the fading impact of corporate tax incentives implemented by President Trump in January, which helped fuel the nation’s exceptional 4.2 percent second quarter growth rate. Another cause might be the current environment of rising interest rates, which increases the cost of borrowing to finance high-cost capital expenditures. Finally, corporate America may be feeling the uncertainty of our ongoing trade disputes which undermine future revenues, profitability and the ability to fund costly purchases and expansions.
But the weakness in business spending was countered by the continued strength of the American consumer. Consumer spending accounts for more than two-thirds of all U.S. economic activity. Personal consumption expenditures – the household purchases of durable and non-durable goods and services such as cars, furniture, food, clothing and education, among others – grew at an annual rate of 4 percent, its fastest pace in nearly four years. This was above the first and second quarter growth rates of 0.5 percent and 3.8 percent, respectively.
So, is this just a temporary downtick in business spending or will it continue into the fourth quarter? Likewise, will the tenacity of the American consumer continue?
The upcoming retail holiday shopping season will be the main barometer for which these questions will be answered. The holiday shopping season is the 61 calendar shopping days in November and December. It can generate nearly 10 times the sales than the industry’s second largest shopping season, back-to-school. According to the National Retail Federation, expected total sales this holiday season are set to reach a record $717-$720 billion, exceeding last year’s total of $687 billion.
Turning to the third quarter corporate earnings season, companies continue to report better than expected earnings and revenues. After three weeks, of the 348 (70 percent) S&P 500 companies that have reported so far, third quarter earnings have increased by 26.2 percent over the past year – above the pre-season estimate of 19.3 percent. Also, third quarter revenues have increased by 7.9 percent – above the initial 7.3 percent estimate.
Similar to last week, of the 11 sectors that make up the U.S. economy, the energy sector continues to report the highest earnings growth rate at 104.8 percent. Rounding out the Top 3 are the financial sector (43 percent growth rate) and the materials sector (29.1 percent growth rate).
The industrial sector, which includes manufacturing and construction companies, ranked fifth last week with an earnings growth of 19.8 percent. This week, the industrial sector ranks seventh with an earnings growth rate of 18.7 percent. So far, 58 of the 71 industrial companies in the S&P 500 have reported, with John Deere due on Nov. 16. And once again, the bottom three sectors for earnings growth are consumer staples, utilities and real estate.