The government doesn’t release its initial estimate on third quarter real GDP for another nine days, but at this point we have enough facts and figures to make an educated guess that it’ll come in at right around a 1.8% annual rate, maybe a little higher, maybe a little lower. Given that the economy grew at a tepid 2.0% annual rate in Q2, we’re sure you’ll hear plenty of angst about slow growth.
But we don’t believe these past quarters represent a permanent shift to slower growth. Productivity growth (output per hour) has picked up from where it was earlier in the expansion – in our view due to tax cuts and deregulation – and so growth is positioned to re-accelerate. Trade angst has likely caused some downward pressure on production and trade, but hurricane Dorian didn’t help either, and the GM strike took a tenth of a percent or so off growth as well. The strike and storm are temporary effects, and we expect some resolution on trade in the months ahead.
Congress could certainly make the trade situation better by passing USMCA (the new NAFTA). And the pressures on both China and the US to sign a first step agreement - or at least call a truce - are high. In the meantime, monetary policy remains loose for economic purposes, suggesting fears of a recession are overblown.
Add up all the numbers, and we get 1.8% annualized real GDP growth. The naysayers will surely use this report to claim victory, but we expect noticeably faster growth in the fourth quarter, led by an improvement in home building and less of a drag from commercial construction. The bottom line is, nothing in the report will suggest a recession is on the way, or that Treasury yields should remain as low as they are today.
So far for Q3 earnings, we have seen 15 (3 percent) of the S&P 500 component companies report their results. Of that three percent, 84 percent of the companies have beaten earnings expectations while 16 percent have fallen short. When looking at revenues, 64 percent of the companies that have reported have beaten expectations while 36 percent have fallen short.
With ongoing uncertainty on many levels for the global financial markets, earnings season will play a very important role in how we finish out the year. If we see companies beat expectations and give upbeat outlooks for the future despite all the uncertainties, we could see markets rise. If corporations do better than the low expectations, but not turn in strong results, we could see increased uncertainty. If Wall Street ends up being correct and we end up with a 4 percent or greater decline in earnings for Q3 2019, the odds of markets moving lower into the end of the year greatly increase.
Economic data also had a noticeable impact on the global markets last week as we saw both good and bad data released. China, always the first major economy to release its quarterly GDP data, released its third quarter GDP growth rate, which came in at 6.0 percent. This represented the slowest quarterly growth rate for the country since it started keeping records back in 1992. Exports to the US fell 21.9 percent on a yearly basis through September, according to the latest numbers, which shows just how much impact the trade war between the two countries is starting to become for China.
Equities: US markets were mostly positive last week with small caps leading the way, while the more concentrated and larger cap Dow posted the only decline of the week. Volumes picked up, over what we have seen the past several weeks, with both the Russell 2000 and the S&P 500 making it to average weekly volume levels, while the tech heavy NASDAQ and Dow saw below average volume. Earnings were the primary reason for the dislocation in performance, as investors continued to push toward small companies in hopes that they will ride an earnings wave higher as they attempt to close the performance gap between large and small companies. It should be noted that the Russell 2000 index remains in correction territory (down more than 10 percent from its highs), while the other three major US indexes are just a few percentage points away from making all-time highs.
Russell 2000 (1.56%) – Average volume
S&P 500 (0.54%) – Average volume
NASDAQ (0.40%) – Below Average volume
Dow (-0.17%) – Below Average volume