Q2 GDP & Corporate Profits
We got more support for the thesis that Q2 will be the fastest growth quarter of the year on Thursday as the GDP report was revised up to 3.1% from 3.0%. This increases the size of the drop that will occur in Q3. The improvement was actually slighter than meets the eye as it went up from 3.049% to 3.06%. Either way the second quarter was great for the economy. The improvement came mainly from the increased inventory investment as the effect on GDP growth was 0.1% instead of neutral. This investment came mainly from farm inventory. Investment on nonresidential structures showed 7.0% growth instead of 6.2% which was originally reported.
Another part of the government report was corporate profit growth. Growth was 0.68% on a quarter over quarter basis and 6.4% year over year. This is less than the S&P 500 profit growth which was 10.3%. This means the smaller companies not included in the S&P 500 had significant underperformance. It’s tough to judge how well small businesses are doing because we only have survey results, but the small caps in the S&P 600 have seen declining margins indicating some relative weakness. Financial industry profits fell 7.1% while nonfinancial sector profits increased 4.9%. The S&P 500 financials sector saw much better results as the quarter over quarter sales growth was 0.96% and there was a 0.18% increase in operating margins.
Jobless Claims
While I though the bump higher in jobless claims was over as the hurricanes have passed, I was mistaken as the jobless claims from last week increased to 272,000 from 260,000; it was 2,000 higher than what analysts expected. Unadjusted claims increased by 8,160 in Florida and 3,157 in Georgia. I expect that to be the last week of them increasing. They should fall back down to normal like what’s happening in Texas. Texas’ unadjusted claims fell by 8,218. Considering the fact that the strength in Texas and the weakness in Florida cancelled each other out, I’m surprised to see the 12,000 increase, but I wouldn’t get too concerned until the results stop getting affected by the weather. By next week, the Florida results will decline and in about a month everything should be back to normal. There may even be a boost in job creation because of reconstruction. Next week’s non-farm payrolls report will take a big hit similar to what’s being seen in these claims reports.
Strong Chicago PMI
The September Chicago PMI was very strong as it increased from 58.9 to 65.2. This is the highest reading in three months and the second highest reading in over three years. The order backlog index increased to a 29 year high. This report made the Q3 average 61.0 which was a one tenth decrease from the 3 year high in Q2. The improvement from backlogs, concentrated demand, and employment were responsible for 60% of the gains while the rest came from increases in production and supplier deliveries. The hurricanes caused a delay in delivery times. According to the responses in the special question, hurricane Harvey caused 38% of businesses’ delivery times to lengthen. They also led to an increase in inventories as that indicator was up 8.4 points which was the highest reading since March.
As has been reported by many manufacturing firms, some companies in this survey cited difficulty in acquiring skilled workers; some firms resorted to hiring temporary workers and causing the staff to work overtime to make up for the fact that they can’t hire new qualified workers as the labor market is tight. Besides the increase in backlogs, the other major takeaway from this report was the increase in inflationary pressures. Prices at the factory gate increased the most since July 2011 because of higher commodity prices and hurricane caused shortages. We have seen a decent bout of commodities inflation in the past few weeks as the CRB commodities index has increased from 166.5 on June 22nd to 183.09 on September 29th. That’s not the inflation the Fed is looking for; it’s the price changes the Fed calls transitory.
GDP Updates
Let’s look at the latest GDP forecast from three of the central banks which publish their models. The forecasts are about as accurate as they can get with the Q3 GDP advanced report coming in 4 weeks. The Atlanta Fed’s report was updated from showing 2.1% growth on September 27th to showing 2.3% growth on September 29th. The forecast was positively impacted by the upward revision to the expected contributions of net exports and inventory investment to Q3 GDP. There was a negative impact from the decline in the expectation of real consumer spending growth and real nonresidential equipment investment growth.
As you can see from the chart below, the NY Fed’s forecast was lowered from 1.56% to 1.46%. This decline was mainly caused by negative data revisions. That counteracted the positive effect from the manufacturing durable goods report. The Q4 GDP estimate fell from 2.01% to 1.95%. Because of rebuilding, I’m expecting a large swing to the positive side in this forecast when the data starts coming out from October. I am expecting Q4 growth to be better than Q3. The St. Louis Fed’s Q3 estimate is for 2.76% growth. With the declines in this forecast and the positive Q2 revision, none of the major forecasts have Q3 growth being faster than Q2.
Conclusion
The key macroeconomic trends that we’ve been following for the past few weeks are continuing. The Florida area is still being impacted by the effects of Irma, while Texas is in recovery mode from Harvey. There will be a modest hit to GDP growth and there will be a big hit to the September jobs report because of the storms. The storms caused delays in shipping and an increase in inflation. It’s interesting to hear from these Fed reports how finding skilled workers is so tough considering the fact that wage growth has dipped in the past few months according to the Atlanta Fed’s wage tracker.
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