A Big Third Quarter

The government’s December 23 final estimate of GDP growth for the third quarter was a massive 5.0% surprise to the upside for the economy. The original estimate in October was 3.1%, which was later upped to 3.9% in November when the Commerce Dept. uncovered surprisingly higher healthcare, consumer and business spending. Using a more thorough survey methodology, Commerce research showed that those estimates were low as well.

The big jump in the third quarter can be attributed to higher business investment, which bodes well for construction and real estate. The biggest driver was the jump in consumer spending, which is a double-edged sword. Here’s what a closer look shows:

Consumer spending has risen somewhat because of better confidence in the future but most of the increase is probably related to the plunge in gasoline prices. The increase in consumer spending was 3.2% or slightly less than $100 billion in the quarter. Gas prices have dropped almost 90 cents during the quarter. The rule of thumb historically is that one penny in gas price decline yields a billion dollars in spending increase. That formula would explain most of the spending increase.

Consumers could also have used that increased disposable income to save more or pay down more debt. Neither of those things happened in the third quarter; in fact, the savings rate declined to 4.1%.

The last time that GDP growth was as strong as the past six months was in late 2003, just before the economy took off. That boom was fueled by consumers, especially consumers using their home equity as ATM’s for depreciating assets or non-assets like vacations. No one expects a repeat of that foolishness again, especially since banks can’t really do what they did in 2005-2006. At the same time, lenders need a place to use cash and Fannie/Freddie are looking at ways to get 97% loan-to-value deals to “qualified” buyers to stimulate home ownership. That’s a huge mistake and is exactly how the housing bubble started. Perhaps we could trust the GSE’s to maintain strict standards but I would rather not.

Better that the next few quarters cool off if that is what is in the cards. the rest of the world is in a bad economic state, which makes investing in U. S. bonds or real estate very attractive. That’s a good thing for our economy.

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