GDP Stunner: 2Q Growth Was Less Than Half Of Forecast

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
August 2, 2016

  1. GDP Grew a Disappointing 1.2% in 2Q, Only 1.0% in First Half
  2. Uncertainty, Over-Regulation Drive Business Investment Down
  3. House GOP’s “Better Way Agenda” – A Good Start at Reform
  4. How the Fed is Likely to React to Disappointing GDP Report
  5. New Hillary Scandal – If True It’s By Far Most Serious To-Date

GDP Grew a Disappointing 1.2% in 2Q, Only 1.0% in First Half

The Commerce Department reported last Friday that gross domestic product, the broadest measure of goods and services produced across the US, rose only 1.2% (annual rate) in the second quarter. That was less than half the pre-report consensus of 2.6%. This was one of the largest misses by forecasters in quite some time.

Yet that was not the only bad news in the report. The Commerce Department also revised 1Q GDP down from 1.1% to 0.8%. That means the economy grew at only a pace of 1.0% in the first half of this year, the weakest start to a year since 2011. The government also revised down GDP for the 4Q of last year from 1.4% to only 0.9%. Needless to say, this was a very disappointing report.

This means that since last September the economy has braked from the 2.2% average during 2012-2015 into a near-stall speed of about 1% growth. Seven years after the recession ended, President Obama on Wednesday took credit for an economy that he called “stronger and more prosperous than it was when we started.”

Never mind that the economy was in a deep recession when he came into office – thus the bar was about as low as it gets. He also failed to mention that the current recovery which began in June 2009 has been the weakest recovery since World War II. But I’m getting ahead of myself.

The only thing really positive in last Friday’s GDP report was the fact that consumer spending showed a robust increase of 4.2% (annual rate) in the 2Q, the best number in a year and a half. Even though consumer spending accounts for over two-thirds of GDP, consumers can’t lift the economy all on their own.

GDP, GDP Growth, Market Uncertainty

The GDP miss last Friday came in large part because of another quarterly decline in business fixed non-residential investment (new factories, equipment, hardware, software, etc.).

Business investment shrank at a 2.2% annual rate in the 2Q. This marked the third consecutive quarterly decline in new business investment as you can see in the chart at left.

Total private business investment, which includes residential and business spending, dropped at a 3.2% pace in the 2Q, the most in seven years.

Apart from a brief stretch in 2014, private business investment in plants, equipment, etc. has been historically weak for the last three years.

Making matters worse, companies downsized their inventories for the fifth consecutive quarter, according to Friday’s report. Inventories were reduced by $8.1 billion in the 2Q, the most since the 3Q of 2011 and subtracted 1.2% points from overall economic growth.

Prior to last Friday’s disappointing GDP report, many economists had been forecasting US economic growth of 2.0% to nearly 3.0% for all of 2016. But after the big miss on 2Q GDP and the downward revisions to the 1Q of 2016 and 4Q of 2015, economists are scurrying to downgrade their forecasts.

I’ve already seen revisions down to only 1.5% to 2.0%. With growth of only 1% in the first half of this year, the economy would have to grow 3% in the second half to average a meager 2%. Most forecasters continue to believe the economy will pick up in the second half of this year, but that remains to be seen.

Uncertainty, Over-Regulation Drive Business Investment Down

Business investment spurs the growth and productivity gains that produce more jobs and ultimately higher wages. As noted above, even though consumers have been resilient, they can’t drive growth by themselves. To get to 3% or better growth, fixed non-residential investment needs to be expanding not declining.

Declining business investment is hobbling an already sluggish U.S. expansion, raising concerns about the economy’s durability as the presidential campaign heads into its final stretch. The investment plunge is a signal that business is on strike, or at least depressed by uncertainty.

Most CEOs will be risk-averse and conservative with their balance sheets until they see signs of a growth rebound, even though they’re sitting atop record piles of cash and the cost of capital is at all-time lows. They will also hold off investing until they have a better sense of the future tax and regulatory burdens they are likely to face next year.

GDP, GDP Growth, Market Uncertainty

They can’t be reassured by what they heard in Philadelphia last week, where the Obama-Clinton Democrats promised more of the policies that have stifled growth the last eight years. For example, Hillary Clinton declared: “Wall Street, corporations and the super-rich are going to start paying their fair share of taxes.”

Start? The richest 1% already pay almost 40% of federal income tax revenue. Maybe Hillary will disclose which sage economic advisers have told her that raising taxes on business will yield more business investment. We already have the highest business income tax in the developed world at 35% at the federal level and another average of 4% at the state level.

President Obama’s unprecedented wave of regulatory costs is another main reason business isn’t investing. Yet Mrs. Clinton is promising more costly rules on finance, health care, drug prices, higher mandated wages and benefits and more.

Normally all of this would help the party that doesn’t hold the White House, but Donald Trump is talking more about law and order and terrorism than the economy. His two main economic themes are restricting the labor force with immigration controls and raising the prices of imports with new tariffs. Both would harm the economy.

Mr. Trump does say he’ll reduce regulation and cut taxes, but he offers few details and these are hardly his main talking points. In his Cleveland acceptance speech, he mentioned them almost as an afterthought.

House GOP’s “Better Way Agenda” – A Good Start at Reform

About the only serious pro-growth agenda being offered today is the House GOP’s “Better Way Agenda” that reportedly would reform the business tax code, ease certain regulations and otherwise remove barriers to business investment and job creation.

In addition to reforms aimed at businesses and creating jobs, the Better Way Agenda includes proposals for serious income tax reform and simplification, reform of healthcare, poverty reduction, national security enhancements and the restoration of constitutional authority.

House GOP leaders have come together with Speaker Paul Ryan to craft these proposals aimed at making America stronger. After several discussions and one meeting with Donald Trump, the Speaker said he’s received assurances from Trump that he’d turn many of the House GOP’s policy priorities into law if he becomes president.

The non-partisan Tax Foundation estimates the Better Way package would make the economy almost 10% larger and lift wages by 8%. Of course, none of this Better Way legislation, assuming the proposals make it through the Senate, is

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