Growth at a snail’s pace

There is an old economic phrase which reminds us of the current economic malaise in our country: “growth recession.” The term refers to an economy which is growing so slowly that it creates net unemployment. The term was created by Dr. Solomon Fabricant of New York University. While technically the economy continues to grow (latest read on second quarter GDP was +2.4 percent; more on that later), business and consumer confidence appears to be very weak.

Nominal GDP as compared with real GDP is extremely weak in relation to historical norms. By our calculations, real GDP is growing by roughly 2.5 percent. Inflation, as measured by the CPI, is up 1.3 percent. Consequently, nominal GDP is growing by 4.3 percent. Since the end of World War II, nominal GDP has grown by an average of 6.9 percent annually. So, the economy on a nominal basis is currently growing at 62 percent of its normalized nominal growth rate.

Now, real GDP-which is the number most of us read about in the papers-is currently growing at roughly 2.5 percent, which is 78 percent of its normalized growth rate. At this level, most economists have been expecting the unemployment rate to start moving to the downside, and earlier in the year we agreed with this view. When looked at on a Nominal growth rate basis, it is more understandable as to why unemployment is not moving downward.

If real GDP was only growing at 62 percent of its normal growth rate, the headline GDP number would be around 1.9 percent. Under this growth rate, the unemployment rate would probably remain elevated as the economy isn’t growing rapidly enough to create new jobs, given the size of the workforce. In other words, economic growth is currently not strong enough to feed the
unemployment bulldog.

Importance to the Stock Market

Why is this information important for stock prices? For a number of reasons; chief among them are earnings growth rates. Since the end ofWorld War II, S&P 500 corporate profits have grown, on average, at a 7.0 percent growth rate. Over that same period of time, nominal GDP growth has been 6.9 percent annually. Nominal GDP growth rates are correlated with corporate profit growth rates. At times, there is some “noise” which occurs where both data streams are slightly different (foreign earnings, as an example). However, corporate profits tend to resemble nominal GDP growth rates over periods of time.

Currently, the “consensus” believes S&P 500 earnings growth is going to be 15 percent for next year. We have a hard time seeing how corporate profits are going to grow to that degree if nominal GDP growth rates are running at 62 percent of normal. We expect to see earnings revision to start a downward march…and this started about a month ago. Normally, the stock market has a hard time gaining serious positive traction when earnings revisions are moving downward. We would not be surprised if the stock market displays periods of weakness as earnings revisions are occurring.

Final Word

Second quarter GDP revision will be released on Friday. Data received since the last read of second quarter GDP tends to lead us to the conclusion that the revision may be negative. We are looking for second quarter GDP growth to be revised downward to less than 2.0 percent growth, from 2.4 percent reported a few weeks ago. This will continue the long chain of negative news regarding the U.S. economy — including recent housing and employment data.

On a very preliminary basis, much of the data released so far for the third quarter is pointing to continued weakness in GDP growth. While we are not officially calling for a “double-dip” recession, as outlined above, the overall growth rate of the U.S. economy is cause for concern and something we will continue to watch closely.
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