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The latest debate is over real (inflation-adjusted) GDP

August 01, 2019
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This Friday, the government will release its initial estimate of real GDP growth in the second quarter, and the headline is likely to look soft. At present, we're projecting an initial report of growth at a 1.8% annual rate. If our projection holds true, we're sure pessimistic analysts and investors will latch onto the slowdown from the 3.1% growth rate for the first quarter, implying that we're back to slower Plow Horse growth for good. They will argue nothing has substantially changed since Trump took office, despite tax cuts and deregulation. 

An annualized growth rate of 1.8% would indeed be the slowest pace since the first quarter of 2017. But, as we will explain below, growth in the second quarter was likely held down temporarily by businesses returning to a more sustainable pace of inventory accumulation following the rapid pace of inventory building in the second half of 2018 and first quarter of this year. 

Excluding inventories - focusing on what economists call final sales - we estimate that real GDP grew at a 3.1% annual rate in Q2. We also like to follow what we call "core GDP," which is real growth in personal consumption, business investment, and home building, combined. Core GDP looks like it grew at a 4.1% annual rate in the second quarter, the fastest pace in a year. 

In other words, while the economy may not be booming like the mid-1980s or late-1990s, the underlying trend remains quite healthy, and certainly much better than the Plow Horse period from mid-2009 through early 2017. 

Last week, the major theme of the markets was earnings as we officially kicked off earnings season with 59 of the S&P 500 companies reporting their results. Financials kicked things off as the first of the major sectors to have many component companies report earning; the results were good. Goldman Sachs saw the largest positive earnings surprise, beating estimates by 23 percent. Capital One beat earnings by 19 percent, while Wells Fargo beat earnings by 12 percent, Morgan Stanley by 9 percent, Bank of New York by 8 percent and JP Morgan by 3.6 percent. The overall blended earnings growth rate so far for the Financial sector is 4.5 percent, the highest of any sector of the markets currently. 

Overall, according to Factset, we have seen 16 percent of the S&P 500 companies report their Q2 2019 results. Of the companies that have reported, we have seen 79 percent beat earnings estimates, while 4 percent have met expectations and 18 percent have missed earnings expectations. The overall blended earnings growth rate now for Q2 2019 is -1.9 percent, which has improved from the -2.7 percent expected at the end of June. However, if we see negative overall earnings for the S&P 500 this quarter, we will technically be in an "earnings recession" as it would represent the second quarter in a row of negative earnings. It would be the first earnings recession that we have seen in the US since Q2 2016. It does not necessarily mean the financial markets would decline, as they did not after Q2 2016, but it would add further weight to an already tired bull market.

Now that does not mean that the secular bull market is over. It merely means that we could see a correction in the third quarter. That would set up a rather nice rally for the final quarter of the year. The market has moved up quickly this year and a correction is always a way to reset the market for the next move. We welcome a correction and do not see it to be a negative surprise but a necessary refresher.
Source : Monday Morning Outlook 7-29-19: Callahan Capital Management Weekly Commentary 7-29-19
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Joseph S. Sturniolo and Associates, Inc.

7535 E. Hampden Street, Suite 501
Denver, Colorado 80231