4.1% GDP Growth Expected Because Of Inventory Investment

4.1% GDP Growth Expected

The Atlanta Fed Nowcast expects 4.1% Q3 GDP growth which is up from 3.6%. The government construction spending growth caused the Atlanta Fed Q3 estimate for real government spending growth to increase from 1% to 1.7%.

The estimate for real personal consumption expenditures increased from 3.5% to 3.7% because of the manufacturing ISM report.

The July manufacturing and trade inventories report caused inventory investment to add an estimated 2.14% to GDP growth which is up from 1.88%.

If inventory adds that much to GDP growth, the market will see right through that great headline number and sell off.

It will be the top story in finance because in the long run inventories don’t help growth. This was bound to happen because inventories were drawn down in Q2, but the exact amount has always been in question.

4.1% GDP growth doesn’t look great if about half of the growth was inventory investment.

4.1% GDP Growth - Update On Canadian Trade Deal

The trade deal with Canada wasn’t substantially different from the Trans Pacific Partnership. Under the USMCA, American dairy producers get access to 3.59% of Canada’s dairy market. This is only slightly better than the 3.25% they would have gotten from the TPP.

The $70 million benefit is the equivalent of 0.0003% of GDP. It’s important to leave the determination of whether it was worth it to enter this trade battle to the political commentators.

It’s up to investors to figure out what this means for asset prices.

The deal is much better than not having one which is why the Dow has rallied so much. You should go long the Dow and short the Russell 2000 if you think a deal with China is coming.

I don’t see any evidence that the tide will turn towards constructive conversations in the near term. However, the slightest positive detail will bring out animal spirits.

Once positive news comes out, it will be difficult to profit off the trade.

4.1% GDP Growth - Construction Spending Growth Accelerates

On a month over month basis, August construction spending growth missed expectations. However, it accelerated on a year over year basis.

It was up 0.1% month over month, missing estimates for 0.4% growth. July’s growth was revised from 0.1% to 0.2%. Growth was revised to 6% from 5.8% on a year over year basis.

As you can see from the chart below, August growth accelerated to 6.5% on a year over year basis. It was helped by easier comparisons.

Residential construction spending growth decelerated from 0.2% in July to -0.7% in August.

Single family spending fell 0.7%; multi-unit spending fell 1.7%. Home improvement spending fell 0.6%. Government spending drove growth as federal spending growth was 5.9%. State and local growth was 1.7%.

Highway and street spending was up 1.7% and education spending was up 1%. Private non-residential spending fell 0.2% because of commercial, power, and manufacturing.

4.1% GDP Growth - Huge Increase In Soybean Stocks

The map below explains the soybean situation which hurt inventories. However, it helped exports in Q2, but is now doing the reverse this quarter.

As you can see, American soybean stocks are up 45% year over year because China has switched to buying soybeans from Brazil.

This is hurting farmers particularly in Illinois which has seen a 124% increase in soybean stocks since last year.

It will be interesting if this pressures America to make a trade deal with China. The overall economy isn’t feeling the heat, but farmers and primary metals buyers are. Price of soybeans is down 10.34% in the past year.

The price decline occurred early in the summer. Market priced in this spike in stocks back then as it is up 1.06% in the past 3 months.

4.1% GDP Growth - Q3 Earnings Update

Q3 earnings season has been great in terms of overall growth and the beat rate, but not amazing in terms of estimates.

Earnings Scout likes to look at Q4 earnings estimates. But I’m still looking at Q3 estimates as well.

As you can see from the chart below, S&P 500 earnings estimates are back to normal in a bad way. Q1 and Q2 were unusual because EPS estimates increased from the start to the end of the quarter.

Q3 is back to normal because estimates have fallen 1.1%. It’s still better than the 5 year average decline which is 3.2%.

When looking at the sector by sector performance, we need to ignore the sector changes in September. They didn’t occur at the start of the quarter.

7 out of 8 sectors saw a decline in estimates, with energy and consumer staples doing the worst. They had 4.4% and 4% declines.

This occurred while the index increased 7.2%. Estimates falling isn’t terrible for Q3 2018 because they came in extremely high.

However, if this trend of estimate declines continues into next year, it will be a problem because their estimates aren’t as fantastic.

According to FactSet, 2019 earnings are only expected to be up 10.3%. That’s around trend growth.

As you can see in the chart below, revenue growth will catalyze half the growth and margins will catalyze about 30% of the growth. Interestingly, the tax benefit falls from 7% to 1%.

38% of the first 16 S&P 500 firms to report earnings had their Q4 estimates raised afterwards and 62% had them cut.

That’s not consistent with a market near record highs. We’ll need to see multiple expansion if stocks are going to increase sharply in 2019.

4.1% GDP Growth - Conclusion

Stocks don’t need estimates to increase throughout the quarter to rally.

However, the combination of lower 2019 estimates and the revival of the trend where estimates decline before results are announced means 2019 probably won’t be a great year for the S&P 500.

I see an economic slowdown and rate hikes standing in the way of 10% gains. If Q3 GDP growth is helped primarily by inventory investment, then the slowdown has already started.

There’s no indication of a recession; it’s more like the weakness in 2016 where stocks corrected and were range bound.

 

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