The Bureau of Economic Analysis (BEA)
released its first estimate of 2nd quarter GDP this week, indicating that the
US economy grew at a seasonally-adjusted, annualized rate of 4%; well above the
median forecast of 3% among 80 economists surveyed by Bloomberg and our own
expectations. The bulk of the growth came from personal consumption
expenditures, which contributed 1.69 percentage points, and inventory
accumulation, which contributed 1.66 percentage points. Personal consumption
expenditures grew at an annualized rate of 2.5%, the midpoint of the range over
the last 18 quarters. In short, consumption was neither particularly strong nor
was it weak. Consumption got a lift from purchases of nondurable goods, which
rose 2.5% after a flat 1st quarter. However, after growing at a 1.3% rate in
the 1st quarter, spending on services grew just 0.70%.
As noted, today’s GDP report included
the BEA’s annual revision, which typically covers the three prior calendar
years. This one also included supplemental revisions dating to the 1st
quarter of 1999. The Bureau revised 1st quarter 2014 GDP higher from
a contraction of 2.9% to a contraction of 2.1%. References above reflect the
revision. Real GDP growth in 2012 was revised lower from 2.8% to 2.3% while
that of 2013 was revised higher from 1.9% to 2.2%. If the 2nd quarter growth
rate holds (it’s subject to revisions in both August and September) and long
anticipated economic acceleration occurs, growth may indeed surpass 2% this
year. However, that in no way alters the
conclusion in our previous post that quantitative easing has not had a substantive
impact on economic growth. The fact remains that growth has been subpar, and
relatively constant, despite quantitative easing.
In its press release, the BEA
“emphasized that the second-quarter advance estimate released today is based on
source data that are incomplete or subject to further revision by the source
agency.” That is always the case for the advance report and only time will tell
if some of the more volatile components are revised higher or lower. However, even
if this figure is revised significantly lower, it’s likely to remain better
than we anticipated. Those that have been bullish on the economy will point to this
report as evidence that the 1st quarter was indeed a weather-related
aberration. Yet, if that is indeed true, it suggests that a significant amount
of the strength exhibited in the 2nd quarter resulted from economic activity
that was pushed out from the first quarter due to weather. In short, if the
weather argument is true, it suggests that the strong 2nd quarter resulted from
the timing of economic activity rather than an acceleration of it. On the other
hand, those of us that have eschewed the weather argument must answer a
different question. If growth truly weakened in the 1st quarter, why did it
rebound so strongly in the 2nd quarter? At least part of the answer lies in
real final sales of domestic product, which is GDP minus the change in private inventories.
Real final sales contracted 1% during the 1st quarter and grew 2.3% in the 2nd.
That suggests a far smaller contraction in demand during the first quarter and
a much smaller increase during the 2nd that is indicated by GDP. While the
difference in the growth rates of GDP over the first two quarters of the year
is a rather enormous 6.1%, the difference in final sales is 3.3%; still
significant, but not nearly as dramatic. There has long been significant
volatility in the rate of inventory accumulation that clearly has little to do
with weather. The chart below depicts
quarterly GDP growth, at seasonally-adjusted annualized rates, along with the
contribution from inventories and all other sources. It is very clear that
inventory accumulation has been a highly volatile component.
Yet, for US equity markets, the strength
or weakness of the economy over the next several quarters is relatively
meaningless. None of the above alters the fact that the market is significantly
overvalued based on one of the most reliable valuation metrics, non-financial
market cap/GDP. According to John Hussman’s
most recent weekly commentary, the ratio of non-financial market
capitalization-to-GDP is 1.35 and the pre-bubble norm was 0.55. The ratio peaked
during the tech bubble at 1.54. Many have suggested that the market is
fairly valued and that stronger economic growth is necessary for stocks to continue
to move higher. However, that assertion is refuted by simple mathematics. If the US economy grew 8%, something it
last did in 1951, every year for the next five years while the equity market
remained unchanged, the ratio would only fall to 0.92. Simply put,
regardless of the rate of economic growth, the US equity market is
significantly, overvalued and that will only change with a significant decline
in equity prices.