The Commerce Department reported that third-quarter GDP increased at a 2.1% annualized rate in its final reading which was in-line with expectations and unchanged from the previous revision. The biggest contributors to growth were consumer spending, the labor market, and construction. Notably, export-oriented sectors and regions continue to show weakness as well. Business investment was down 2.3% overall but all the contraction was in manufacturing-related areas.
More importantly, this weakness is offset by strength broadly distributed throughout the economy. Overall, this circumstance has been sort of a "goldilocks" scenario for financial markets. The localized, intense weakness results in increased bearish sentiment, defensive positioning, and loose monetary policy due to fears that that weakness will infect the rest of the economy.
In turn, these factors create optimal conditions for stocks to relentlessly advance as they did for most of 2019 especially when the overall economy remains resilient. This scenario played out from late 2012 to late 2014, mid-2016 to late 2018, and potentially repeating itself currently.
Consumer Spending Higher, Corporate Profits Lower
The biggest surprise in the GDP report was consumer spending which led many analysts to upgrade fourth-quarter and full-year GDP estimates. Strength in consumer spending reflects lower unemployment, higher wage growth, and increased confidence among workers in the economy's strength.
One potential warning sign in the report is that corporate profits were down $23.1 billion or 1.2% compared to the third quarter in 2018. This follows a 0.6% decline in the previous quarter. Although it's too soon to say with certainty, corporations may be unable to raise prices. If wages do continue to rise, this would be a potential threat to stocks as earnings and margins would decline and possibly even impact valuations. Rather than a recession in the broader economy, this is a more probable bear market catalyst.
Fourth-Quarter GDP Preview
Entering the fourth quarter, there was speculation that the economy may contract considering the downward spiral in manufacturing data. However, these concerns seem absurd now. Manufacturing data seems to be bottoming, the jobs report was exceptionally strong in October and November, and real-time GDP estimates moved from slightly negative to above 2% following the torrent of improving data.
One potential risk to fourth-quarter GDP is Boeing's
