Strong economic growth in the second quarter

by: , Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

Key insight

We expected the economy to accelerate in the second quarter, driven in part by fiscal stimulus from tax cuts and increasing government spending. Looking ahead, while we expect economic growth to remain robust, the second quarter could be the high water mark for the year, as growth tapers off somewhat in the second half.

What happened?

The U.S. economy showed solid growth in the second quarter, as Gross Domestic Product (GDP) was up 4.1% (annualized) versus the first quarter. That is the fastest growth pace since 2014.1

Accelerating consumer spending and exports as well as growing federal and state/local government spending were the key drivers of the strong headline number, while businesses appear more cautious on spending than many expected given the tailwinds from tax reform and global growth.

U.S. GDP growth

Sources: Thomson Reuters Datastream, New York Life Investments, as of 7/26/18.

Consumers doing well, supported by strong income growth

As widely reported by retailers, the second quarter showed solid consumer spending (+4.0%). This is a rebound from a disappointing first quarter, but consumer spending is clearly supported by solid household income growth as disposable personal income is up 5.7% (annualized) year-to-date, supported by strong job growth and tax cuts.

Lean inventories bode well for third quarter

Business inventories declined, presumably because demand surprised on the upside, as business production failed to keep up with final demand. Inventories subtracted 1% from second quarter GDP growth, which means that the growth pace of final sales (what was actually bought for use in the second quarter) was above 5% for the first time since 2006. Lean inventories bode well for activity and hiring in the third quarter, if consumer demand trends remain steady.

Strong trade, but business capital spending shows signs of caution

While the acceleration in exports is good news and a sign that tensions around tariffs are, so far, not causing major disruption in trade patterns, business capital spending did not accelerate. In fact, nonresidential business investments showed weaker growth than in the first quarter. This is disappointing, given the magnitude of profit growth that is signaled by incoming earnings reports. This indicates that multinational companies with global supply chains remain cautious about major investment projects given the cloudy outlook for trade deals and tariffs.

Why does it matter?

Broad-based economic growth is key to corporate revenues and profits, which are crucial to stock markets. Strong GDP growth indicates that the remaining corporate earnings reports for the second quarter will continue to show solid headline numbers.

Bottom line

With solid growth in the second quarter, solid trends in demand, lean inventories, and most leading indicators pointing to a growth pace above trend in the next couple of quarters, odds are now good that the economy could reach an overall growth print breaching the 3% mark for 2018 as a whole – a feat that has not been accomplished for a full calendar year since 2004.

The 4.1% growth print of the second quarter could be the “high water mark” for the year, as growth in the second half of the year is set to taper off somewhat. Still, the report is good news for financial markets, as strong demand from consumers, government spending, and overseas markets show that U.S. business revenue trends and cash flows are strong.

1. Bureau of Economic Analysis.

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Poul Kristensen, CFA

Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

Poul Kristensen, CFA is Managing Director, Economist, and Portfolio Manager with New York Life Investment Management’s Strategic Asset Allocation & Solutions (SAS) Group

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