Q3 GDP Will Be Best Of Year

Today was the biggest day of the earnings season with giants Amazon and Alphabet reporting among a slew of others. However, tomorrow’s focus will also be on the Q3 GDP report which is likely to be the best of the year. While it will be the best of the year, baring a shocking report, it will still be weak in terms of the average economic recovery. This economic recovery has been the weakest in decades and this report will not change that.

I’m expecting the GDP report to miss expectations which are set at 2.9%. My reasoning is the Atlanta Fed’s GDP Now forecast is expecting the GDP report to be 2.1%, as you can see in the chart below. The average error over the past two years in this forecast is 0.4%. Since the likely range of the report is somewhere between 1.7% and 2.5%, the economists’ consensus estimate is outside of that range. The highest estimate for Q3 is 3.3% and the lowest is 1.3%. I am going to guess the report will be a slight miss from the Atlanta Fed’s projection given the fact that I have a negative bias on every economic report because the business cycle is ending.

gdp-now

If we get a report of 1.8%, that would be over a 1% miss from expectations. In the future we may look back at this quarter as being a pivotal tipping point in the stock market because it was the quarter where expectations were too high. There is a consensus that the economy will recover from the very slow growth in the past 3 quarters, but if we continue at the rate we have been at, the estimates for 2017 will have to come down. This is the same story when it comes to earnings expectations as I mentioned in a previous article. Because earnings always beat expectations, this quarter is really expected to show growth even though the consensus going into the period was for a 2% decline. If earnings growth is less than 1% and GDP growth is less than 2%, the wheels of the market may finally come off their hinges.

When predicting when a recession will start, one comes up against the reality that a recession may have already started. It certainly has started in the manufacturing and industrial area of the economy already. As you can see below, core durable goods orders are down for the 21st straight month. Business spending declined 1.2% month over month. This is the longest non-recessionary contraction in durable goods orders in history. How can one predict where the recession will start, by looking at data like this? The economy is slowly grinding to a halt opposed to falling sharply like what has occurred in the past. This doesn’t necessarily indicate that the recession will be long and benign like the recovery has been.

core

What makes forecasting a recession even more difficult is trying to determine whether the past few years have even been a real recovery. How does one forecast a recession without a recovery? I would like to see the look on Fed officials’ faces when they see the two charts below, because I truly wonder if they understand the situation we are in. As you can see in the first chart below, the past 2 recoveries have been weak. The 1990s tech bubble was the first of the 3 bubbles. The ensuing recovery in the early 2000s didn’t get labor force participation rate up to full employment. This current recovery hasn’t even been close to getting us up to full employment as there are 15.1 million missing jobs.

The second chart showing real final sales paints a similar picture. The growth rate has never rebounded to the baseline growth like it has in past economic hiccups. With demographics weakening and productivity declining, the economy relies on credit growth. When the credit cycle ends, I expect the next recession to be even worse than the last one as government debt and corporate debt is higher than ever before.

ballpark

Conclusion

You can cheer the Q3 GDP growth being better than the recent trend until you are blue in the face, but it will likely be worse than expectations. If we are still in this recovery, it reinforces the notion of how weak it has been. When the credit cycle ends, I expect a worse recession than what occurred after the financial crisis. It will tough for economists to figure out when it started because of the negativity we have seen for 21 months in core durable goods orders which is one of several indicators which has been negative for quite some time.

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