A cottage industry has sprung up in the past decade with the sole focus of discrediting any good news on the economy. When President Obama was in office, the attacks mostly came from the right. With Presi dent Trump in Office, the attacks mostly come from the left. Since March 2009, regardless of who was in office, we have stridently argued that this recovery has legs.
The latest debate is over real (inflation-adjusted) GDP, which grew at a better than expected 2.1% annual rate in Q2. Some say it showed soft spots from the trade war and weak business investment.
It's true that net exports (exports minus imports) trimmed the Q2 real GDP growth rate by 0.65 percentage points. But that follows the Q1 boost to growth of 0.73 points. In the past year, trade has subtracted an average of 0.58 points each quarter. For comparison, we saw larger drags from net exports in 2010, 2014, and 2015, all years without "trade wars." Our conclusion: this is statistical noise.
That leaves real business fixed investment, which declined at a 0.6% annual rate in Q2, the first drop since 2016. Many have taken this as proof that tax cuts and deregulation didn't work. The Q2 decline was almost entirely due to a drop in brick and mortar investment (what economists call "structures"). In the age of the Internet, software and computers are replacing brick and mortar. We buy airline tickets online, not in an office. Blockbuster was replaced by Netflix. You don't need to leave the comfort of your home, the stores come to you. As a result, investment in structures has slowed in recent years while investments in technology and equipment have continued to rise. Strip out structures, and real fixed investment rose at a 1.9% annual rate in Q2 2019.
More importantly, business investment ex-structures has clearly picked up under the Trump Administration compared to Obama's second term. Why only use the final four years of the Obama Presidency? Because the first four years were driven by a V-shaped recovery from the Panic of 2008. His second term illustrates the impact of tax hikes and more business regulation.
Real business investment, excluding structures, grew at a 3.8% annualized rate between Q4 2012 and Q4 2016, but accelerated to a 5.9% annualized rate since Trump took office. Real Investment in software and R&D grew at a 5.5% annualized rate in the final four years of the Obama Administration versus 7.5% since the start of 2017. Tax cuts and deregulation have indeed boosted "animal spirits."
In addition, Core GDP – combining personal consumption, business investment, and home building – grew at a very solid 3.2% annual rate in Q2. Meanwhile, profit reports are widely beating expectations. The economy is much stronger than conventional wisdom thinks and has been since 2009.
The equity markets advance continued last week on the strength of better-than-anticipated earnings reports. This week’s expected 25 basis point interest rate cut by the Federal Reserve, and ongoing trade discussions with China, provided additional support. The Nasdaq’s 2.26% gain led the indices followed by the Russell 2000® Index (+2.01%), the S&P 500® Index (+1.65%) and Dow Jones Industrial Average (+0.14%).
Earnings season yielded mixed results as trade, weather, uncertainty over global economic growth have influenced earnings and sentiment. Overall earnings results thus far have exceeded modest expectations; with reports from over 25% of companies in the S&P 500®, approximately 78% exceeded estimates. In the Technology sector, Google beat earnings with impressive growth while Amazon missed earnings due to slowing revenues in cloud storage and higher expenses. Commentaries, while generally positive, also reflect the uncertainty of trade negotiations and tariffs. Revised projections by the International Monetary Fund lowered 2019 global economic growth projections from 3.3% to 3.2% and increased projected growth in the U.S. from 2.3% to 2.6%.
Expectations remain low for meaningful progress as trade negotiations resume in China this week. Apparently, as a goodwill gesture, China is resuming imports of certain U.S. products without imposing tariffs. A mid-size bank, with significant exposure in China, maintains an upbeat outlook as its business with Chinese companies and individuals remains positive. The bank commented that China has taken steps to permit foreign companies to own a majority interest in Chinese companies; also, China has lowered the list of banned industries from near 500 to approximately 48. The bank also commented on increased lending activity as companies borrow to relocate production to other Asian countries.
The United Kingdom’s newly-elected Prime Minister, Boris Johnson, stated his intention to implement Brexit by the October 31 deadline with or without an agreement. Mr. Johnson, with the support of his new, pro-Brexit cabinet, will soon initiate discussions with the European Union regarding opportunities to negotiate terms; the EU’s chief Brexit negotiator commented he was prepared to “work constructively” to analyze “any UK idea on withdrawal issues that are compatible with the existing withdrawal agreement.”
This week Earnings will likely continue to provide market momentum absent any significant news on trade or monetary policy.
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
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