U.S. Economy: GDP Revised Upward; Manufacturing Indicator at Highest Point in 14 Years
U.S. growth domestic product (GDP) for the second quarter was revised upward in late August. In its second estimate of GDP for the second quarter, the Commerce Department reported1 that the economy grew at an annualized rate of 4.2%. The upward revision primarily reflected strong business investment which was partly offset by a downward revision to consumer spending. Real, or inflation-adjusted, GDP increased 2.2% in the first quarter.
The Commerce Department’s report showed that consumer spending – which makes up more than two-thirds of the country’s total economic output – rose at annual rate of 3.8% in the second quarter, revised from an initial reading of 4.0% when the Commerce Department released its first estimate of GDP growth in late July.
Overall, the most recent estimate of GDP growth was the strongest since the third quarter of 2014, when annualized growth was 4.9%. Economists expect the U.S. economy’s current expansion to continue. According to a survey of more than 60 economists taken in August by The Wall Street Journal2, the consensus estimate for third-quarter GDP growth is projected to be 3.2%. Still, a growing number of economists – slightly more than 58% in the August survey – see more downside risks to their GDP forecasts over the next 12 months.
With continued strength in the labor market, signs that inflation is on the upswing (average hourly earnings are up 2.9% over the year, according to the latest employment report3 released in early September), and strong economic growth, the Federal Reserve Open Market Committee (FOMC) may be poised to raise short-term interest rates at its two-day meeting on September 25-26. The Fed will also update its projections for interest rates during the meeting.
In the coming weeks and months, economic data may be skewed due to Hurricane Florence which was approaching the East Coast and expected to make landfall on September 15.
Strong ISM Manufacturing Growth May Point to Further Expansion
A recent survey of the nation’s manufacturing economy found sustained new order growth domestically, but did indicate signs that the manufacturing sector is being negatively impacted on the international front from tariff-related issues. The Institute for Supply Management4 (ISM) said that its purchasing manager’s index for manufacturing rose 3.2 percentage points from the previous month to 61.3 in August – its highest point since May 2004.
ISM’s new orders index rose 4.9 percentage points, or 8.1% from the previous month. That was the most since August of 2014, though export orders fell to a 10-month low and import orders declined to an 11-month low, according to LPL Financial’s research blog5.
Timothy Fiore, chairman of ISM’s manufacturing survey, said price pressures continue, even as that index has declined for three straight months. Demand is still robust, though labor shortages, supply chain inefficiencies and tariff-related concerns remain. “Respondents are again overwhelmingly concerned about tariff-related activity, including how reciprocal tariffs will impact company revenue and current manufacturing locations. Panelists are actively evaluating how to respond to these business changes, given the uncertainty,” Fiore said in ISM’s news release.
Strong manufacturing activity has consistently preceded significant phases of GDP growth, LPL Financial says. Over the past five business cycles, the U.S. economy has fallen into a recession an average of 46 months, or 4 years, after ISM’s manufacturing index has peaked.
The potential for future economic and market growth remains strong, LPL Financial says, acknowledging that manufacturing may be especially susceptible to future weakness from trade tensions and cooling in trade activity is already evident in a divergence between domestic and international orders.
“However, we believe the tailwind of fiscal stimulus will continue to overwhelm any negative impact from trade tensions and supply chain disruptions, buoying manufacturing and strong economic output through the end of this year,” LPL Financial said in the blog post.
Real Estate: Home Prices Moderating; Starts and Sales Trending Lower
While economic growth and the job market remains strong, the housing market is still mired in slowing sales growth, exacerbated by higher mortgage rates and tighter inventory levels. Home prices, however, are showing signs of moderating.
The Census Bureau6 reported that privately-owned housing starts at a seasonally-adjusted annual rate of 1,168,000 in July were up by 0.9% compared to June’s revised rate, but 1.4% lower than a year ago. And compared to the previous month, existing home sales fell 0.7% in July to a seasonally-adjusted annual rate of 5.34 million.
The current sales pace for existing home sales is 1.5% lower than that of a year ago. Sales have also fallen on an annual basis for five straight months, according to the National Association of Realtors7(NAR).
Brighter prospects were evident in the new home sales market. New single-family home sales in July were at a seasonally-adjusted annual rate of 627,000 – 1.8% below June’s revised figure, but 12.8% above July 2017’s sales estimates, according to the Census Bureau8.
With this year’s rising mortgage rates, borrowers with a $250,000 30-year fixed-rate mortgage are paying roughly about $1,000 more in principal and interest compared to last year, according to figures from Freddie Mac. Mortgage rates surged in the first half of 2018, for the most part tracking rise in the yield on the 10-year Treasury note.
While rates have stabilized somewhat, Freddie Mac expects a gradual upward trend with the 30-year fixed rates to average 4.66% this year and 5.10% in 2019, Freddie Mac said in a forecast published August 279.
Thirty-year fixed mortgage rates in early September stood at 4.60% compared to 3.78% a year ago – the biggest year-over-year increase since May 2014. Mortgage rates will likely edge higher as the Federal Reserve considers short-term interest rates at its meeting later this month and at future meetings, according to Freddie Mac10.
Looking ahead, annualized comparisons for mortgage applications “may look weaker than they appear,” primarily because of the large spread between current mortgage rates and last September – which represented a low for 2017, Freddie Mac says.
As far as housing prices, figures from real-estate brokerage firm Redfin11 show that prices rose 5.3% in July to a median $307,400 compared to a year ago. However, the growth rate in prices has been falling for five consecutive months and hasn’t been this low since September 2016.
Homes sold in July went under contract in a median 35 days – three days faster compared to last year, but a day slower than in June. Redfin, though, notes there are signs that competition among buyers for available properties is waning. For the first time since March 2015, the share of homes that sold above asking price declined year-over-year to 26.2% from 26.5% in July 2017. Though that figure retreated slightly, 28% of homes on the market in July had a price drop – the largest share on record since Redfin began tracking that figure in 2009.
Global Stocks: U.S. Stocks Still Outpacing Other Markets Overseas
Turmoil in emerging markets push some indexes near bear market territory
Strong corporate earnings remain a firm foundation for U.S. stocks despite the recent surge in average hourly earnings, prospects for higher interest rates and turmoil in emerging markets. Additional signs of slowing growth in developing markets in Europe has also helped underpin the bullish tone for U.S. stocks.
The S&P 500 index hit a few record highs during August and posted a record close of 2,914.04 on August 29, according to S&P Dow Jones Indices12. For the month, the S&P 500 was up by more than 3.0% while the Dow Jones Industrial Average gained nearly 2.2%. The Nasdaq Composite gained more than 5.7% ─ and continued its strong surge this year passing the 8,000 mark for the first time on August 27.
Among the so-called core U.S. indexes compiled by S&P Dow Jones Indices, the S&P SmallCap 600 gained 4.72% in August and is up 30.67% over the past year – the best performance of any of its core indexes. The Russell 2000 also hit new records in August and is up 13.37% this year through the end of August.
The sentiment that smaller companies may be more insulated from trade turmoil than their larger multinational peers has been a boost to small cap stocks in recent months. These companies have also benefited from the cut in the corporate tax rate, but may also post stronger earnings from consumer spending and economic growth.
“As we move into the second half of the year, the market environment is positioned well for U.S. small cap equities to remain one of the preferred markets,” Stifel’s global head of investment strategy Michael O’Keeffe said in a note to clients in late August published in this report13. “Small business owners continue to anticipate greater sales and even better business conditions for the remainder of the year. We expect this to result in increased investment spending that ultimately leads to GDP growth.”
Overseas, global stocks have struggled to keep pace with the performance in U.S. markets. The S&P Global Broad Market Index was up 0.70% for August compared to the previous month, but without the 3.26% gain from the U.S., that index was down 2.12%. The S&P Emerging BMI Index fell 3.78% for the month and is down by 8.87% for the year through August, according to S&P Dow Jones Indices.
A closer look at emerging markets reveals that some equity benchmarks have fallen into, or near, bear market territory. The MSCI Emerging Markets Index has fallen by 19.7% from a high in late January through September 7. In Hong Kong, the Hang Sang Index, an index of 50 stocks, of which more than half of its components are mainland Chinese companies, has fallen by 18.6% for the same period.
Tighter financial conditions in the U.S., meanwhile have begun to take its toll on emerging market currencies, particularly Argentina’s peso and Turkey’s lira. The stronger U.S. dollar is also making it more costly for companies in emerging markets to raise or refinance dollar-denominated debt, while bond yields are also higher. The current environment raises concerns over the outlook for the global economy.
In late August, FTSE Russell’s US Financial Conditions Index, a broad-based measure of financial conditions that includes interest rate expectations, the money supply, balance sheets and bond spreads, reached close to 4 for the first time since early 2007. Philip Lawlor, FTSE Russell’s managing director for global market research, said in this August 23 blog post14 that tightening U.S. financial conditions “suggest we are close to the end of this phase of robust global growth.”
The flattening yield curve in the U.S. bond market, recent selloff in commodities and “fading trend” in forward-looking forecasts for economic growth “all suggest that the global cycle is peaking,” he said, in the blog post.
Commodities: Falling Demand May Be Indicating Slowing Global Economic Growth
Oil supply, productivity also expected to influence prices for the rest of the year.
Commodity prices remained under pressure for most of August, partly due to the selloff in emerging market countries’ stocks, bonds and currencies. Concerns over the potential impact of the Trump administration’s trade policy and expectations that a further $200 billion or so more of tariffs will be announced against Chinese goods have also weighed on prices in recent weeks – given the Chinese economy’s importance to commodity consumption and prices.
Oil prices, too, have been trading within a narrow range as market participants consider whether this year’s price increases will begin to cut into demand – particularly from emerging market nations – and how production from OPEC (the Organization of the Petroleum Exporting Countries) will respond to declining crude oil exports from Iran with the November deadline looming for the implementation of U.S. sanctions.
The Bloomberg Commodity Index was down by 1.9% in August. After reaching near a two-year high in late May, commodity prices as tracked by that index have declined by 10.9% through the first week of September. Copper, too, has also fallen significantly. Since June 8, the price of copper on COMEX is down by 21.0% through September 7.
Additional pressure on commodity prices has come from the strengthening dollar – which makes it more expensive for Chinese manufacturers to purchase raw materials. In addition, as emerging market nation’s currencies decline against the greenback, mining producers in those countries tend to ramp up supply since they’re paid in dollars.
In the energy market, meanwhile, higher prices earlier in the year have also begun to weigh on demand and forecasts for oil output and prices for the rest of the year. Brent crude was up more than 4.0% in August compared to the previous month, while West Texas Intermediate (WTI) crude gained about 1.5%. For the year through August, Brent has gained nearly 16.0% and closed at nearly $77.00 a barrel as of September 7. WTI crude is up by more than 12.0% this year through August and was trading at around $67.75 a barrel as of September 7.
Prices for Brent crude, the global benchmark for oil, were typically about 45% higher during the second quarter of 2018 compared to a year ago, according to the International Energy Agency (IEA).
And while demand was strong earlier in the year, it fell in the second quarter. The IEA now expects that global oil demand will grow by about 1.0 million barrels per day in the second half of the year, compared to a forecast of 1.4 million barrels per day in the first quarter when the market had been growing by about 1.8 million barrels per day.
“In OECD [Organisation for Economic Co-operation and Development] Europe, oil demand fell below last year’s level in 2Q18, and in the US, falling gasoline demand has contributed to more than the halving of total demand growth in 2Q18 versus 1Q18,” the IEA said in its August Oil Market Report15.
Ole Hansen, head of commodity strategy for Danish banking group Saxo Bank, notes that recent production surveys show that OPEC has been able to offset the beginning of a production slowdown in Iran, with Libya the main contributor of supply. The outlook, though, points to a period where OPEC’s total production is likely to decline as the Iranian slowdown accelerates.
“Rising oil prices due to the short-term impact of US sanctions may, however, create a medium-term challenge for demand growth. This as emerging markets, the main source of demand growth, suffer from a perfect storm of rising oil prices and weaker currencies,” Hansen said, in a report released in early September16.
On the other hand, oil prices could be on the rise again later this year if supply constraints from Iran and less production from U.S. shale producers begin to cut into output. Growth in the number of rigs drilling for oil in the U.S. has stalled since May amid productivity increases as well as pipeline and transportation bottlenecks – particularly in the Permian basin.
“A higher oil price scenario is built on lower exports from Iran due to U.S. sanctions, capped U.S. shale output growth, instability in production in countries like Libya and Venezuela and no material negative impact from a U.S./China trade war on oil demand in the next 6-9 months,” Harry Tchilinguirian, oil strategist at French bank BNP Paribas, said in this September 10 report on CNBC17. Under that scenario Brent crude would trade above $80 a barrel, he told Reuters Global Oil Forum, as cited in the CNBC report.
Sources for Financial Data:
Dow Jones Industrial Average:
MSCI Emerging Markets Index:
Hang Seng Index:
The Bloomberg Commodity Index:
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