The first estimate for the 3rd quarter came in at 1.5%, eliciting comments of a slowdown from the 2nd quarter’s 3.9% growth.
But beneath the surface, key drivers of the economy remained strong. Excluding the trade and inventories categories, GDP rose at a 2.9% rate. This speaks to the health of the consumer, who continues to benefit from job and income gains, low inflation and low energy prices.
It also highlights the contrast painted here over the last few months between weakness in manufacturing/international trade and strength in services and domestic consumption.
After-tax incomes for American workers rose at a 3.5% annual rate (inflation adjusted), which allowed them to save more while still expanding consumption at a respectable rate. The 3rd quarter savings rate increased to 4.7% from 4.6%. It’s a good sign when consumers are able to both spend more and save more.
[Read: Past the Halfway Point of Q3 Earnings]
Regarding inventories, a slower build reflects inventory levels that have crept higher, but it also reduces drag moving forward.
Overall, the latest results put the economy on track to expand at a mid-2% rate, very close to last year’s growth rate of 2.4%
On Wednesday the Fed held off on raising rates, but signaled the possibility of a move in December. As much as they would like to raise rates, they are still beholden to their dual mandate of maximizing employment and achieving 2% inflation.
On the latter, the latest Personal Consumption Expenditures figures were released today and showed a further tick down in headline inflation. Core PCE remained steady at 1.3%, but overall prices are only up 0.16% from year-ago levels.
Add in the fact that import prices are down 10.7% year-over-year and producer prices are down 1.1% year-over-year, and it’s difficult to make a case for near-term rising inflation.
And then there is this …
Renewed dollar strength will continue to exert downward pressure on multinational corporate revenues, import prices, domestic manufacturing, commodities, and emerging markets … all negatives, and all items that could influence the Fed to stay their hand.
The prospect of delayed lift off in the US, combined with actual and expected easing measures by central banks overseas, has triggered a massive rally in stocks. The rebound has been remarkable, but the euphoria is due to wear off.
In the chart below we can see the S&P approaching overbought levels as it arrives firmly back inside the trading range that characterized the first half of 2015. Massive run-ups typically require a period of consolidation to digest the gains, and there’s a good likelihood we could see that soon.
I’ve been vocal about calling the August swoon a correction, as it was heavily driven by worries over China, emerging markets and monetary policy, and didn’t accurately reflect the impact to US fundamentals. While that call may turn out correct, it doesn’t negate the fact that we are in the later stages of this economic expansion, and still up against major global headwinds.
The sharp drops in August may have been painful, but they were a good wake up call for many investors who had become complacent. If you found yourself overwhelmed at the time, it’s a signal that perhaps you have too much exposure. And if that’s the case, periods such as this are the ideal time to lighten up. For obvious reasons you want to calmly sell into strength, as opposed to joining the emotional panic sellers.
Corrections are a natural part of markets and they do hurt, but they also provide a needed dose of reality. They force us to reassess our positions and outlook, and that makes them valuable, whether we want to admit it or not.
The preceding content was an excerpt from Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
