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Ahead of Wall Street

Wednesday, July 30, 2014

This morning’s strong GDP report provides further confirmation of the bounce-back in the economy and serves as a favorable backdrop for this afternoon’s Fed announcement. The Fed isn’t expected to spring any surprises today, but the GDP report will increase market chatter about the central bank’s longer-term plans.

The GDP report shows a strong Q2 bounce-back in the economy from the first quarter’s ‘shocking’ dip in the negative territory, which was also revised up in today’s release. The U.S. economy expanded at a +4% annual pace in Q2 relative to expectations of +3% growth and the Q1 decline of -2.1% (revised up from the original -2.9% decline). Gains in consumer spending, inventory investments, spending by businesses and even the government gave us the big Q2 bounce.

Consumer spending was up +2.5% in Q2 vs. +1.2% in Q1, with spending on durable goods doing most of the heavy lifting (up +14% vs. +3.2%). Business capital spending, referred to as non-residential fixed investment in the GDP accounts, increased +5.5% in Q2 vs. up +1.6% in Q1. Housing (residential fixed investment) was up +7.5%, reversing the -5.3% decline in Q1.

The only less than positive part of the GDP report is the big contribution from inventory investments, a volatile component from period to period. Inventories contributed +1.66 percentage points to the 4% GDP growth – it had subtracted 1.16 percentage points in Q1.

The problem with a big inventory build is that it needs to be offset in the coming quarters if not sold to consumers, becoming a drag on growth in the following period’s GDP tally. That’s why sometimes it’s better to look at the growth in Final Sales instead of the ‘headline’ GDP growth rate. Final Sales, which strip out the impact of inventories, were up +2.3% in Q2 vs. down -1% in Q1.

All in all, a very good GDP report, with the bounce-back in consumer and business spending particularly notable. As long as the improving jobs market continues to add to households’ buying power, we should expect favorable momentum on the spending front. This morning’s ADP (ADP - Analyst Report) jobs report confirms the overall improving trend in the labor market even though it was a tad bit shy of expectations.

The GDP report will justifiably dominate the headlines this morning, but we remain in the thick of the Q2 earnings season and we would like to share the updated Q2 scorecard following this morning’s earnings releases. Including this morning’s reports from Humana (HUM - Analyst Report), Hess (HES - Analyst Report) and others, we now have Q2 results for 303 S&P 500 members that combined account for 68.86% of the index’s total market capitalization. Total earnings for these companies are up +8.7% from the same period last year on +5% higher revenues, with 69% beating EPS estimates and 64% coming out with positive revenue surprises.

As we have been saying repeatedly in our earnings commentary in recent days, this is better performance than we have seen in awhile: growth rates are better, more companies are beating estimates, and there is even some modest improvement on the guidance front.

Sheraz Mian
Director of Research

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