Key Takeaway: Our forecasts for domestic economic growth continue to be proven most accurate and we continue to anticipate things will get a lot worse from here.
REVIEWING THE DATA
What did we know coming in:
- Trade Balance: Global growth was slowing, export demand would remain weak and the trade balance was going to be a drag
- Industrial Recession: Domestic manufacturing and industrial activity (negative growth Durable goods, Core Capex & Factory Orders) were going to be soft
- Investment: Inventory levels and Inventory-to-Sales ratios were at cycle peaks (ISM, Census Bureau) and likely to be a negative contributor
- Government: Government was probably not going to be an outlier and may provide some modest upside with spending getting a little pop into fiscal year end
- Consumption: Consensus was looking for consumption to singularly carry the growth load. We knew from the July/Aug PCE data that household spending would again be good on an absolute basis although the slope of the line would remain in retreat off the 1Q15 peak. Further, with retail sales (i.e. good consumption) flagging, services consumption would carry the consumption load
What did we get: Headline Real GDP growth slowed to 1.5% QoQ SAAR with year-over-year growth decelerating for a 2nd straight quarter to 2.0% from +2.7%. No real surprises with Consumption contributing almost all of the headline gain, Government providing a small positive contribution, Investment tanking and Net Exports contracting.
- Consumption: Contributing +2.19 to headline and decelerating QoQ to +3.2%. Services had outsized positive impact with Healthcare adding a notable +50bps to headline. To reiterate, Consumption was again good on an absolute basis but the slope of the line remains negative with 3Q representing a 2nd quarter of deceleration off the 1Q15 peak. Consumption comps get tougher from here and income growth (i.e. the driver of the capacity for consumption growth) is likely to moderate alongside slowing payroll gains.
- Investment: Contributing -0.97 and declining -5.6% QoQ with deceleration across the board. Both Residential and Nonresidential Investment decelerated sequentially and Inventories contributed a remarkable -146bps to the headline number
- Government: Contributing +30 bps but decelerating -90bps QoQ
- Trade Balance: More balanced than expected but still a modest negative contributor.
- Deflator: GDP price index and Core PCE decelerated sequentially (on QoQ basis) with core PCE coming in at 1.3% for the quarter
What did we learn: Policy makers look at GDP sub-aggregates to gauge the strength of underlying domestic demand independent of international factors and some of the more volatile components. Each were better than headline growth, but all decelerated sequentially.
- Real Final Sales (GDP less Inventory Change): decelerating -90bps sequentially to +3.0% QoQ SAAR
- Gross Domestic Purchases (GDP less exports, including imports): decelerating -210bps sequentially to +1.5% QoQ SAAR
- Real Final Sales to Domestic Purchasers (GDP less exports less inventory change): decelerating -70bps sequentially to +2.9% QoQ SAAR
REFRESHING THE OUTLOOK
Updating the GIP Model: The +2% YoY growth rate recorded in 3Q15 represented a -70bps deceleration from 2Q15’s +2.7% YoY growth rate and a -90bps deceleration from the cycle-peak recorded in 1Q15. In conjunction with a +10bps acceleration in the average rate of CPI during the quarter, the U.S. economy landed squarely in #Quad3 for the third quarter of 2015. Our forecast range of +1.6% to +1.9% YoY (which translates to +0.5% to +1.7% QoQ SAAR) for 4Q15E implies the U.S. economy is likely to close out 2015 with a third straight quarter in #Quad3. From the perspective of our proprietary asset allocation strategy process, 3Q15 was as classic a #Quad3 outcome as one can find. Specifically, within both equities and fixed income, the factor exposures which have typically performed best during historical episodes of #Quad3 performed best during the quarter and the factor exposures which have typically performed worst during historical episodes of #Quad3 were among the laggards this time around. We expect this trend to continue – with one caveat: the policy adjustments of Draghi (ECB), Kuroda (BoJ) and Carney (BoE) should continue to perpetuate deflation throughout the commodity complex via a stronger USD (CLICK HERE for more details).
#Quad3 LONGS: Utilities (up +4.4% in 3Q), REITS (up +2.0% in 3Q) and Treasury Bonds (10Y Yield down -32bps in 3Q):
#Quad3 SHORTS: S&P 500 (down -6.9% in 3Q), Materials (down -17.3% in 3Q), Financials (down -7.2% in 3Q) and High Yield Credit (Yields up +148bps and OAS up +154bps, on average, in 3Q):
Reviewing the Base Effects: Largely due to how we model GDP using a proprietary Bayesian Inference Process, 3Q15 marked the third straight quarter in which our model has pinned-the-tail-on-the-advance-GDP-estimate-donkey (see: 1Q15 and 2Q15). Notwithstanding the fact that the Bloomberg Consensus estimate for 3Q15E peaked at 3% QoQ SAAR in August, we continue to espouse the merits of modeling the macro economy like any thoughtful analyst would model a micro company – on a YoY basis. Refer to our 9/2 white paper titled, “Do You QoQ?” for a detailed explanation of this omnipotent distinction. Simply put, when base effects accelerate and/or remain elevated for an extended period of time, growth rates tend to slow on a trending basis. The opposite outcome holds true for growth rates that encounter decelerating and/or consistently subdued base effects. All told, U.S. Real GDP growth slowed right on queue into steepening base effects in 3Q15. Moreover, these “comps” are set to remain extremely difficult for the next four quarters, which implies the sine curve of underlying U.S. economic growth that oscillates between +1% and +3% is likely to mean revert back to the low end of that range of probable outcomes over the next few quarters. Indeed, domestic economic growth is now well past its cyclical and structural peaks and history has proven that rolling off the latter is bad.
Assessing Our Predictive Tracking Algorithm: Not much to say here other than the loss of sequential momentum is now obvious to anyone who dares to view the data. With the domestic industrial and earnings recessions ongoing, the risk to consensus forecasts for domestic economic growth is primarily centered on hopeful expectations for the U.S. consumer. But with various metrics of household consumption growth and gauges of services sector activity rolling off their respective ~10Y-highs, we continue to find it more appropriate to position for trending deceleration in these metrics, rather than improbable suspension of economic gravity. As we penned in our 10/27 note titled, “Is the Bear Market Priced In?”, this is a run-of-the-mill #LateCycle Slowdown in which inflation and capital expenditures peak and roll first, followed by employment growth and ultimately by consumer spending. No sense in making it any more complicated than that.
All told, feel free to rely on our competitors’ forecasts for domestic and/or global growth and inflation at your own risk. As the only accredited firm that actually called for the 2015 industrial and earnings recessions that would stem from our 2014 #GlobalDeflation call, we believe we have more than earned enough ethos to help steer investors to the right side of the mid-cycle (Consensus Macro) vs. late-cycle (Hedgeye) debate.