The last week has brought the first estimates of 2Q GDP from every region of the world. They are a varied bunch, with growth disappointing in some place (US, France,) but surprising in others (S Korea) whilst arriving much as expected in others (Eurozone, Spain, UK, Taiwan).
When we look at the foundations of growth, however, we discover that the shape of world growth is shifting, with challenges emerging in the anglo-saxon economies which have been leading the post-crisis grinding expansion, whilst sources of new potential growth are emerging in unexpected places such as the Eurozone and S Korea. Whether the improvement in fundamentals in such places can fully compensate for the deterioration in the current growth-leaders is unclear. This piece looks in more detail at the US GDP disappointment, and explain how it masks an underlying early upturn in profits.
The biggest 2Q GDP disappointment so far came from the US, where not only was the advance estimate an anaemic 1.2% annualized, but in addition 1Q growth was revised down to just 0.8% annualized (from 1.1%), and 4Q15 was cut to 0.9% (from 1.4%). Within the 2Q result, there was strength from personal consumption (up 4.2% annualized), and from net exports, where 1.4% rise in exports and a 0.4% fall in imports allowed net exports to add 24bps to growth.
The drags were obvious enough: private non-residential investment fell 2.3% annualized, residential investment fell 6.1%, and government consumption fell 0.9%. Finally, there was a marginal quarterly fall in private inventories - the first since 3Q11 - which stripped 116bps off annualized growth.
However, the outsize hit represented by inventory changes hints that perhaps the result was not quite so bad as it first appears. Excluding the change in inventories, final sales rose 2.4% annualized, which was double the growth rate now claimed for both 1Q16 and 4Q16, and slightly above the 2% averaged since 2010. In nominal terms, 2Q GDP growth annualized to 3.5%, which is slightly below the 3.7% averaged since 2010, but still the strongest since 2Q15. Excluding inventory changes, nominal final sales of domestic product rose 4.7% annualized (beating the post-2010 average of 3.7%).
The result, then, is not quite the disaster it first appears. However, without upward revisions (the gap between the advance result and the 3rd estimate is usually +/- 50 to 60bps), it is probably weak enough to weaken further the foundations of the expansion. That, however, is a marginal call.
The good news: even at the shockingly low level of nominal GDP growth (annualizing at 3.5%, but up just 2.9% on a 12ma), it looks as if the decline in the ROC directional indicator is at least approaching its cyclical low point. (No guarantees, actually - it depends on whether nominal GDP growth has bottomed).
The bad news: the slowdown in growth is hitting labour productivity, with output per worker deflated by capital per worker falling 2% a year, the steepest decline since 2009. GDP per worker fell 0.5% yoy, which by itself it unexceptionable - there were steeper declines in 2013, but this is accompanied by a 1.5% yoy rise in nominal capital per worker, which is the strongest rise since 2010. Whilst the 2% yoy decline remains very modest by pre-crisis standards, the danger is still that it caps labour market strength in the short-term, if there is no positive revision.
This leaves us on something of a cliffhanger as far as US prospects are concerned. A positive trajectory could be achieved in which nominal GDP accelerates to beyond the 3.6% needed to outstrip capital stock growth, at which point ROC and profits would begin to inflect upwards, and the expansion be renewed. The negative trajectory is one in which the fall in output per worker results in a slackening in labour markets, which in turn undermines personal consumption, which is currently the mainstay of GDP growth. In these circumstances, nominal GDP would struggle to recover to the 3.6% level needed to reverse the fall in ROC, and the expansion would continue to slow.
Which is more likely? Today’s personal income and savings data for June supplies some details. First, it confirms that the robust growth in personal consumption during 2Q is at least partly attributable to a fall in the personal savings rate. In June the savings rate fell to 5.25%, which is the lowest since the tax-driven lows of late 2013, and on an annualized basis, dollar personal savings were down 4.4% mom and down 7.3% yoy - the first yearly yoy fall since (again) late 2013.
What the chart makes very clear is that after climbing steadily throughout 2015 and 1Q16, savings and savings rates tumbled dramatically during 2Q16. This is why by June personal spending could still be running at an annualized 3.7% growth even though income growth slowed to 2.7%. During 2Q, average annualized personal savings actually fell by 1.3% yoy, or by US$10.4bn yoy, to $763.1bn.
This fall in the savings rate plainly suggests a vulnerability in the consumption spending which underpinned 2Q’s GDP growth. In doing so, it shifts the balance of probability towards the negative scenario.
But it is not the end of the story, for the decline in the household savings rate is part of the reason why the corporate savings rate - ie, profits - are on the rebound. When we estimate the entire private sector savings surplus for 2Q, it seems likely that it has recorded a slightly rise from 2Q15, with my current estimate suggesting a US$18.4bn yoy improvement - which is just enough to keep the 12m PSSS steady at around 2.1%. If so, it suggests that corporate profits have also probably risen, by something in the region of US$28.8bn yoy during 2Q.
And this is also the conclusion you reach when you estimate corporate profits applying equations to the data in the national accounts (ie, where profits = (compensation minus consumption) +(exports minus imports) +(taxes minus govt spending) + net investment.) These calculations suggest not only that corporate profits as a % of GDP are continuing the recovery seen since 3Q15, but are also rising approximately 12.5% yoy in 2Q16, pushing the 12ma to 2.5% - the highest since the 12m to the beginning of 2015.
The S&P’s expectation of a modest profits recovery emerging in 2H16, to reverse 2015’s 2.9% fall, followed by a stronger recovery (13.1% yoy) in 2017 seems reasonable.
A relatively modest recovery in profits does not entirely rule out the possibility of recession, still less ensure an early and powerful rebound. Nevertheless, current circumstances look more reminiscent of the mid-1990s slowdown, and the 2012/13 ‘soft patch’ than the onset of recession. In the short term, the indicator to watch will be capital goods orders and shipments, which tend to respond quite quickly to shifts in ROC and profitability. At present, like most of the other indicators I’ve mentioned, the latest evidence is equivocal: orders for capital goods rose 0.2% mom in June, but shipments fell 0.4% mom, and although this pushed the book/bill ratio up slightly, it remains below long-term trend, as it has since 4Q14, with no immediate prospect of recovering to trend. This book/bill ratio has now been below trend for 20 months, which is how long it spent below trend during the 2008 - 2010, but below the 30 months seen during 2000-2003.