The Economy Surges Higher, But Is It For Real? by Gary D. Halbert

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
September 29, 2015

IN THIS ISSUE:

  1. 2Q GDP Report Was Better Than Expected at 3.9%
  2. The Problem With How the Government Measures GDP
  3. Janet Yellen’s Supposed “Flip-Flop” on Monetary Policy
  4. Fed’s Latest Uncertainty Leads to More Turmoil in Stocks
  5. Sunday’s Rare SuperMoon, BloodMoon & Lunar Eclipse

Overview

Today we look at last Friday’s better than expected final report on 2Q GDP, which was revised from 3.7% to 3.9%. Best of all, this increase was largely due to increased consumer spending which accounts for almost 70% of GDP. Following the paltry 0.6% increase in GDP in the 1Q, this means the economy grew by 2.25% in the first half of this year.

While a 3.9% jump in economic growth in the 2Q was welcome news, there is a growing consensus that such reports from the government may not be remotely accurate. The problem is, many agree, that the government’s “seasonal adjustments” to the monthly and quarterly data have gotten out of control, and the numbers reported are no longer reliable. We’ll talk about this below.

Next, we’ll look into what many are calling a “flip-flop” on the part of Fed Chair Janet Yellen in the last two weeks on the subject of when short-term interest rates are likely to be raised. At the Fed’s latest policy meeting on September 17, they decided to postpone the first rate hike in nearly a decade, seemingly indefinitely. But then last Thursday, Yellen said lift-off will happen before the end of this year, and this sparked the latest selloff in the equity markets. So, what gives?

I will close today with a few thoughts about the SuperMoon, BloodMoon and lunar eclipse we saw on Sunday night. I hope you got to view it.

And finally, our latest WEBINAR with ZEGA Financial is now available for viewing on our website. ZEGA’s strategy for using options is one of the most interesting I have ever seen.

2Q GDP Report Was Better Than Expected at 3.9%

The US economy expanded more than previously estimated in the second quarter on stronger consumer spending and construction, the second upward revision in a row. The Commerce Department said on Friday that Gross Domestic Product rose at a 3.9% annual pace in the April-June quarter, up from the 3.7% pace reported last month. This was the third and final estimate of 2Q GDP.

The rise to 3.9% beat the pre-report consensus of 3.7% and was driven by growth in consumer spending, mainly on services like health care and transportation. Consumer spending, which accounts for more than two-thirds of US economic activity, was revised up to a 3.6% growth pace in the 2Q from the 3.1% rate reported in August, helped by cheap gasoline prices and relatively higher house prices which are boosting household wealth.

Economy

Revised construction spending data helped to push up the headline figure, with non-residential fixed investment expanding 4.1% in the quarter. The revisions to 2Q growth also reflected a smaller accumulation of business inventories than earlier estimated.

Private-sector inventories grew by $127.5 billion in the second quarter, close to the growth in the first quarter. Most forecasters expect slower inventory accumulation to shave off one percentage point from the 3Q growth rate, leaving it slightly above 2%. It now looks like the economy will do well to record 2.5% growth for the whole year.

After-tax corporate profits were also stronger in the 2Q than previously thought. Profits after-tax with inventory valuation and capital consumption adjustments were revised to show a 2.6% rebound from a slump in late 2014 and early 2015, instead of the 1.3% increase reported last month.

The better than expected performance in the 2Q followed the paltry 0.6% pace in the 1Q. In the first three months of the year, a harsh winter and a port slowdown on the West Coast forced many companies to keep their products on the shelf rather than selling them.  As a result, the economy grew at only a 2.25% pace in the first half of the year, a slightly higher pace than in the first half of last year.

The Problem With How the Government Measures GDP

More and more analysts are questioning how the Commerce Department measures GDP (as well as other important government economic reports). Economists are questioning how it is that we’ve had paltry 1Q GDP followed by a surge in the 2Q for several years now. As a result, more analysts are questioning the Commerce Department’s statistical methods that are used to estimate the output of America’s 320 million people.

One explanation is that the numbers we are shown are not in fact the numbers which the statistical offices actually collect. The numbers we are shown often include large “seasonal adjustments” and variations. Seasonal adjustments are intended to smooth-out the data to reflect that there are, for example, more lifeguards working in the summer months than in the winter, and more ski-lift operators in the winter than in the summer.

Likewise, there are hundreds of thousands of temporary workers hired around the Christmas holidays to work in stores and do holiday deliveries, who then get laid off around January 1.  The government tries to account for these distortions and many others and seasonally adjust for them throughout the year.

The problem, many now believe, is that the government’s seasonal adjusting is out of control, so much so that the data we see may be far from close to the actual measurement. For example, a recent Brookings Institute research report found that with the correct amount of seasonal adjustment based on weather, the lousy 0.6% growth in the 1Q would have improved to 1.4%. That, in turn, would have made the 2Q come in at 2.8% instead of 3.9%.

In addition to the GDP reports, seasonal adjustments apply to many government economic reports we receive including jobs, housing, etc. As a result, it is very hard to make serious decisions when we know the numbers can change significantly from one report to the next.

Finally, before we leave the subject of GDP, let’s take a look at the Atlanta Fed’s latest GDPNow estimate of where the economy stands as of last week. We can see that most analysts have lowered their 3Q GDP forecasts since late July but their median expectation is still around 2.5%. Yet the Fed’s estimate now stands at only 1.4%.

Economy

The latest decline occurred last week when the model’s forecast for 3Q real residential investment growth fell in response to the existing home sales report from the National Association of Realtors. We don’t get the first Commerce Department GDP report for the 3Q until late October.

Janet Yellen’s Supposed “Flip-Flop” on Monetary Policy

The Fed surprised a lot of people around the world on September 17 when its policy committee decided to keep interest rates near zero for a while longer. In the press conference following that meeting, Yellen said, “In light of the heightened uncertainties abroad and a slightly softer expected path for inflation, the Committee judged it appropriate to wait for more evidence.

That decision led a lot of Fed-watchers to conclude that the first

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