Friday, we received the durable goods orders and Q4 GDP report. The durable goods headline report of -0.4% growth month over month looked worse than it was because of sharp declines in defense spending. The 1.9% Q4 GDP growth rate headline was weak as it missed the Atlanta Fed’s GDP Now expectation for 2.9% growth. It missed the New York Fed’s Nowcast which expected 2.1% growth. Economists expected growth to be 2.2%, so it also missed their estimates. The 1.6% growth for 2016 was the slowest rate since the recession. This can change after adjustments are made to the report. The headline accurately portrays the underlying report as it was a mixed bag with many of bad individual metrics and a few silver linings.
The chart below shows U.S. capital goods orders remaining weaker than a few years ago. You can see why I would think there would potentially be a recession by the end of 2016 because of the trend lower. However, at the end of the year, there was a stabilization in manufacturing.
As I mentioned the durable goods orders headline of -0.4% growth month over month looks bad on the surface. It missed expectations for 2.3% growth, but the reason wasn’t as ominous. Defense capital goods orders are volatile. They fell 33.4% month over month. Without this anomaly, the report showed 1.7% growth. This is still below the 2.3% expected, but not by much. Orders of non-defense capital goods excluding aircrafts rose 0.8% which was the 3rd straight month of growth. The orders for motor vehicles and parts were up 2.7% in 2016 and only 2.0% in December. It’s a bad sign than December growth was worse than the year’s total given the high level of discounting in the month. In fact, the weak demand is the reason for this discounting. I expect 2017 to have lower than 2.7% growth. This will be a drag on durable goods orders.
The chart below shows the 1.6% GDP growth rate in 2016 being the slowest since the recession. The growth rate would’ve been lower if the Q3 soybean export driven growth anomaly didn’t occur. On the positive side, the 1.9% Q4 growth rate can be adjusted higher in the future. The Q4 growth rate decreasing from the 3.5% growth in Q3 isn’t a sharp deceleration because Q3’s number was boosted by soybean exports. A summary of the report would be the economy is seeing ‘more of the same’ weakness, instead of a sharp drop-off which signals a recession is imminent.
Delving into the report, the weakness was mainly caused by a 4.3% decline in exports and an 8.3% increase in imports. The led to the -1.7% net trade seasonal adjusted annual rate seen below. A large portion of the this is probably caused by the strong dollar. It really accelerated its bull run in Q4. Because the dollar has sold off about 3% from its peak in December, this means the net effect of trade on GDP growth won’t be as bad next quarter. Trump is advocating for a weaker dollar which would help exports, but his tariffs will hurt the growth of trade which will damper any future positive effects.
As you can see from the chart below, there was a big boost in inventories which helped the report. Inventories growing boosted GDP growth by 1% which was double last quarter. Inventories increased at a rate of $48.7 billion in Q4 which was up from $7.1 billion in Q3. Increased inventories can be construed as a negative if you think future demand will be weak. Businesses think demand will be strong which isn’t a surprise given the level of optimism we’ve seen from them in sentiment reports.
Personal consumption’s seasonally adjusted annual rate of growth was 1.7% which slowed from the past 2 quarters. It was up slightly from last year which may signal the holiday season sales were solid, but unspectacular. Considering the amazing consumer polls, this number is disappointing. Jumps in sentiment seem to have over-highlighted the positivity the consumer is feeling.
The positive part of the report was business investment. The question is if this investment is mistaken. It may be based on overly optimistic sales forecasts. We’ll soon see whether the sales turn into reality or if this investment was a bad idea. Spending on business equipment increased 3.1%. This was caused by a surge spending on mining exploration, wells, and shafts which was up 24.3% compared to being down 30.0% in Q3. This spending won’t be able to maintain that pace if oil prices decline into the $40s like I am expecting due to the rampant speculation on the long side of the futures market. There was also a big boost in residential construction which was up 10.2% on an annualized rate and added 0.37% to GDP growth.
Finally, inflation picked up which isn’t a surprise. Inflation growth seems to have stalled since December, but this report includes the last 3 months of the year, so it makes sense it would show higher inflation. The price index for gross domestic purchases increased 2.0% in Q4 which was higher than the 1.5% increase in Q3. The PCE price index was up 2.2% which is higher than the 1.5% increase last quarter. This was driven by energy price increases because excluding energy and food, it was up 1.3% compared to the 1.7% increase last quarter.
The GDP growth is going to be more political in 2017 than it has been in the past. Usually politicians point to it as a measure of their success or their opponents lack of success. President Trump is explicitly promising 4% GDP growth, so the number will be more important. The focus of the Obama presidency was unemployment and for Trump it’s GDP. In theory, this would be good for the economy, but the presidents don’t control the business cycle which means the next downturn will occur whether politicians like it or not.
Conclusion
2016 was a terrible year for economic growth. The silver lining is manufacturing picked up at the end of the year. Usually a sub 2.0% GDP growth rate signals we are about to go into a recession, but because this recovery has been the weakest since 1949, I’d say to expect more of the same stall speed growth in 2017. The question is “if GDP grows between 1.5% and 2% in 2017 and corporate earnings grow about 5% can stocks continue to rally?” That’s my vision for the best-case scenario. We’ll see if the tax cuts and regulatory reforms prove me wrong.
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