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3rd Quarter GDP Observations

Date Posted: October 26, 2018

Third Quarter Real GDP Report—Slightly Better Than Expectations
Third quarter real GDP (advance estimate) increased 3.5% compared to the prior quarter — slightly better than expectations. Compared to the third quarter of 2017, real GDP increased 3.0%.

Consumers Still King — Holiday Season Key to Fourth Quarter GDP Outlook
Contributors to the increase included consumer spending (4.0%), inventory build (2.1%), and Federal Government spending (3.3%) — particularly for defense (4.6 %). Once again, consumers, which represent more than two-thirds of real GDP, proved king showing a 4.0% increase in personal consumption expenditures. A 2% inventory build contributed importantly to the quarterly growth. With expectations of a strong holiday season, the inventory build should not prove surprising. At the same time, some of that build may reflect inventory hedging in front of further tariff increases. Key to fourth-quarter GDP growth will be whether the strength of holiday season spending proves sufficient to bring down the third quarter inventory build.

Business and Residential Construction a Drag on the Economy
Not all of the economy showed strength in the last quarter. Business investment in structures declined nearly 8%, the weakest quarter since the fourth quarter of 2015. Weakness also showed up in residential construction with a decline of 4%. Excluding services, goods exports declined 7%, which also represents the worst performance since the fourth quarter of 2015 and disappointing considering our increasing energy exports.

Final Sales Growth of 3.1% a Good Measure of Real Economic Activity
Final sales to domestic purchasers represent, in effect, what went across the sales counter. In our view, this gives a better sense of economic activity in the quarter by stripping out primarily inventory change and some government spending. For the quarter, final sales showed growth of 3.1%.

PCE Inflation 1.6% Below Fed’s “Goal”—Fed Will Stay the Course
The personal consumption expenditures (PCE) price index increased 1.6% in the quarter below the Fed’s 2% goal and 2% reported in the last quarter. Many investors will see this lower number as pushing the Fed to rethink increasing the Fed Funds rate four times next year. In our view, the Fed will persist in that program. Very simply, this PCE inflation index result represents one piece of data. We also see the need for the Fed to put in place tools to deal with an eventual economic slowing as the prime reason.

Investment Conclusions
The economic and investment outlook for the fourth quarter and first half of 2019 will depend on economic momentum carrying further into 2019 than many economists expect. The fourth quarter, in particular, will depend on consumers opening their wallets. The third quarter showed some wallet opening with a modest decline in the personal savings rate from 6.8% to 6.4%. The strength of consumer spending in the fourth quarter holiday season will depend on both growth of incomes and a willingness to spend from personal savings. Finally, we remain of the view that the power of Fed normalization policies will likely be the ultimate influence tempering the economy and financial markets in the latter half of 2019.