Third Quarter GDP - My Take

Ok, GDP out this morning - everyone and their brother will be analyzing and pontificating on this, so I will leave most of it to them.  I will, instead, just focus on what I am looking at in the release.  The bottom line, in my view, is that growth is decent but not truly robust.  Numbers are no longer coming off a significantly weak base.  I am still cautious in my expectations, but not gloomy nor pessimistic. 

Profits from current production (corporate profits with inventory valuation and capital consumption adjustments) increased $26.0 billion in the third quarter, compared with an increase of $47.5 billion in the second quarter.  Current-production cash flow (net cash flow with inventory valuation adjustment) -- the internal funds available to corporations for investment -- decreased $68.4 billion in the third quarter, in contrast to an increase of $61.1 billion in the second.

Ok, we have to expect a slowdown from the 2nd Q pace, but this is a little much.  The funds available for investment is especially troubling as cost cutting measures cannot propel growth much longer.   But the bright spot:

Domestic profits of financial corporations increased $34.6 billion in the third quarter, in contrast to a decrease of $3.4 billion in the second.  Domestic profits of nonfinancial corporations increased $0.3 billion in the third quarter, compared with an increase of $48.2 billion in the second.  In the third quarter, real gross value added of nonfinancial corporations decreased.

I am still keen on the banks across the capital structure as I do not believe risk premiums fully reflect the improvements to the business and the capital positions.  I primarily focus on the bigger banks as many of the regionals  have more work to do.  Now, with that in mind, we still have BASEL to contend with and coming regulation that could diminish trading profits and reduce profits on the retail side.

Now, for me the tricky part is deciphering the following:

The change in real private inventories added 1.61 percentage points to the third-quarter change in real GDP, after adding 0.82 percentage point to the second-quarter change.  Private businesses increased inventories $121.4 billion in the third quarter, following increases of $68.8 billion in the second quarter and $44.1 billion in the first.

 Was the inventory build in expectation of future sales or as a result of lower than expected sales?  I have to think it is a combination of the two, judging from Q3 conference calls.  Corporate leaders did not show the bubbly confidence one would expect if they were building inventories for future growth.

GDP Thoughts

Looking at the US GDP release for some clues as to the corporate condition, I do not see much to be overly optimistic about.

1.    Profits from current production (corporate profits with inventory valuation and capital consumption adjustments) increased $47.5 billion in the second quarter, compared with an increase of $148.4 billion in the first quarter.  Current-production cash flow (net cash flow with inventory valuation  adjustment) -- the internal funds available to corporations for investment -- increased $61.1 billion in the second quarter, compared with an increase of $33.3 billion in the first.  The cash flow number looks pretty good.

2.Domestic profits of financial corporations decreased $3.4 billion in the second quarter, in contrast to an increase of $5.2 billion in the first.  Domestic profits of nonfinancial corporations increased $48.2 billion in the second quarter, compared with an increase of $117.2 billion in the first. 

3.    Profits before tax increased $15.3 billion in the second quarter, compared with an increase of $224.5 billion in the first.  The before-tax measure of profits does not reflect, as does profits from current production, the capital consumption and inventory valuation adjustments.  These adjustments convert depreciation of fixed assets and inventory withdrawals reported on a tax-return, historical-cost basis to the current-cost measures used in the national income and product accounts.  The capital consumption adjustment decreased $0.8 billion in the second quarter (from -$169.9 billion to -$170.7 billion), compared with a decrease of $106.9 billion in the first.  The inventory valuation adjustment increased $32.9 billion (from -$36.4 billion to -$3.5 billion), compared with an increase of $30.8 billion.

While Positive, we can see that corporate profit growth is slowing (as of Q2) and I would not be surprised to see it slow further in Q3.

Stocks are rallying on the news.  What exactly is there to cheer about?  The overall GDP number - +1.7% - was above expectations (+1.6%), but by no means strong. Prices are under control (+0.1%) and possibly heading lower (this, however, would not be good) and personal consumption was better (+2.2% vs +1.9% in Q1).  

Treasuries are rallying on the news (this I get), shaving a couple of bps off their yield.  10s are now 2.48%, 5s at 1.26%.

Yee haa, always moving.  Good hunting.