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A Moderate Recovery - More Of The Same

Contributed by Raymond James

The advance estimate of 3Q12 GDP growth was not far from expectations. Consumer spending growth was moderately strong, while business fixed investment was a bit weak. The details suggest that some of the headwinds may be abating, although risks are tilted to the downside.

Real GDP rose at a 2.0% annual rate in the advance estimate for 3Q12. That figure will be revised, and revised again, but the story isn’t likely to change much. Domestic Final Sales (GDP less net exports and the change in inventories) rose 2.3% (vs. +1.4% in 2Q12). Consumer spending rose at a 2.0% pace, a bit less than expected. Business fixed investment fell 1.3%, a smaller decline than was anticipated. Spending on equipment and software was flat, a contrast to the reported sharp drop in shipments of nondefense capital goods ex-aircraft.

Residential fixed investment rose at a 14.4% annual rate – a large increase, but that added only 0.3 percentage point to overall GDP. The improvement in the housing sector is a positive for GDP growth, and is likely to add comparable amounts to GDP growth over the next several quarters, but it’s not a game changer. Yet, we’ll take whatever we can get.

Third quarter GDP growth was boosted by an increase in defense, which added 0.6 percentage point to overall growth. One unusual characteristic in this recovery has been the contraction in state and local government. However, that appears to have neared an end. As the economy sank into a steep recession, tax revenues dried up, leading many state and local governments to cut spending. A third of the $800 billion fiscal stimulus was aid to the states, which helped offset some of the budget strains. However, as the stimulus faded, the budget strains were still there. The downturn in state and local government jobs intensified last year. More recently, the drag from state and local government has been flattening.

The pop in defense spending in 3Q12 wasn’t unusual, but it’s unlikely to be repeated (moreover, we may see some reversal in 4Q12). The bigger concern is the impact of the fiscal cliff in 2013. About half of the scheduled spending cuts would be in defense. The consensus view remains that most of the pain will be postponed no matter who is in the White House. Interestingly, polls of consumers suggest little worry about the fiscal cliff. Many workers are unaware that payroll taxes were lowered in the last two years, so that may not be much of a surprise. In contrast, businesses are well aware of the repercussions. The National Association of Manufacturers estimates that over a million private sector jobs will be lost if the full fiscal cliff hits (although that seems a bit overstated).

Looking ahead, the economic outlook will be a battle of headwinds and tailwinds. Residential homebuilding, auto sales, and a very accommodative Fed are positives. A weak global economy and tighter fiscal policy are negatives. Gasoline prices, which should be falling, remain an important wild card.