Upward Revision in 3rd Quarter GDP Lifts Markets

By Chris Puplava, November 29, 2006

The Bureau of Economic Analysis released the preliminary estimate for third quarter 2006 gross domestic product (GDP), which showed the economy grew 2.2% on an annualized basis, up from the advance estimate released last month that reported growth at 1.6%.

The markets responded favorably to today's revision of 2.2%, which was larger than the consensus estimate (Thomson Financial Consensus) of 1.8%. The main contributing factors to the upwards revision came from lower imports, higher inventories and greater consumer spending on services that were somewhat offset by a downward revision to consumer spending on durable goods.

The largest drag on GDP was residential fixed investment, which was down an annualized 18% from the second quarter and has been in a downtrend since peaking in the second quarter of 2005.

Figure 1

Source: Moody's Economy.com
Data: BEA

By component percent contributions to real GDP, the highest contributor was personal consumption expenditures, which added 1.99% to real GDP, with government expenditures and investment coming in second, adding 0.42%. Gross private domestic investment came in flat, adding 0.01% to GDP while the largest drag on came from net exports, which shaved off 0.21%. The housing sector (residential fixed investment), which had been a positive contributor to real GDP, turned negative this year and shaved off 1.16% from real GDP. Over the past two quarters the investment in residential structures has declined by an annualized rate of 15%, marking the biggest contraction since 1990.

Figure 2

Source: Moody's Economy.com
Data: BEA

It's not hard to understand the negative contributing trend to GDP from residential investment as housing continues its contraction. Much like the movie, The Perfect Storm (2000), where the fishermen saw a clearing in the clouds and thought they were going to make it out of the storm before the clouds closed once again, today's release of new homes sales for October, which surprised to the downside with downward revisions to prior months, showed the housing storm clouds closing again after opening a bit in August and September with the housing sector still not out of the storm yet. New home sales fell 3.2% to 1.004 million annualized units in October, with the positive news in the report showing that the median price for a new single-family home rose 1.9% on a YOY basis. However, the months� supply of homes rose to 7.0 in October from the upwardly revised 6.7 (previous 6.4) September reading. The increase in supply came from a 3.8% increase in completed homes for sale in October, with completed homes for sale up 33% over the past six months, which will continue to put downward pressure on prices.

Figure 3

Source: Moody's Economy.com
Data: Bureau of Census

The existing homes data that came out yesterday also showed an increase in the months� supply of existing homes to 7.4 months, while the median existing single-family housing prices fell by 3.5% in October on a YOY basis, the steepest decline on record.

Figure 4

Figure 5

Source: Moody's Economy.com
Data: National Association of Realtors

While the overall economy is growing below potential due to a large part from the contracting housing market mentioned above, the corporate sector continued its record growth in the third quarter, this despite high energy prices and fears of a consumer retrenchment. Corporate profits rose 31% on a year-over-year (YOY) basis and up 4.2% from the second quarter of this year. Corporate profits increased $66.2 billion at an annualized rate in the third quarter to $1,658 billion. After-tax corporate profits as a percent share of GDP fell slightly to 8.5% from its all-time high in the second quarter.

Figure 6

Source: Moody's Economy.com
Data: Bureau of Census

Oil & Gas Inventories

The Energy Information Administration (EIA) released their weekly petroleum report that showed crude oil inventories falling 0.3 million barrels last week, larger than the 0.1 million barrel draw down expected. Distillate inventories showed a larger decline, down 1.0 million barrels against expectations of a 0.4 million barrel drawdown. Gasoline stocks also fell, down 0.6 million barrels though in line with expectations.

Figures 7 & 8

Source: Energy Information Agency (EIA)

Inventories for distillates and gasoline fell this week despite an increase in refinery utilization, which rose to 88.07% last week, up from the prior week's rate of 87.08%. The drop by distillates of 1.0 million barrels is surprising as refinery utilization rose as did distillate imports, rising to 298,000 barrels/day last week, up from 205,000 barrels/day in the prior week. The decline in distillate inventories came against a backdrop of mild winter weather in the Northeast displaying the strong demand for distillates. With distillate demand this strong during mild winter weather in the Northeast, colder winter weather may put significant pressure on distillate inventories. Distillate demand is higher than last year's levels, which is contributing to the distillate inventory decline that has been falling at a consistent rate and is now within the average range after being significantly above the average as early as a month ago.

Figures 9 & 10

Source: Energy Information Agency (EIA)

Today's Market

The stock market rose today on the positive news of the third quarter revised GDP numbers which showed that the economy was in better shape than original numbers that showed third quarter growth below 2% at 1.6% annualized rate. The DJIA nearly posted a triple digit gain, rising 90.28 points to close at 12,226.73. The S&P 500 was up 12.76 points to close at 1399.48, and the NASDAQ was also up, rising 19.62 points to close at 2432.23. The 10-year Treasury note yield rose to 4.521%, and the dollar index posted a small gain on the day, rising 0.36 points to close at 83.49. Advancing issues represented 77% and 65% for the NYSE and NASDAQ respectively, with up volume representing 80% and 69% of total volume on the NYSE and NASDAQ.

Energy commodities were up on the day after the release of the EIA petroleum report with the strongest gains seen in heating oil (+3.8%) followed closely by 1-month Henry Hub natural gas futures (+3.75%). Precious metals were mostly down, with gold falling $3.60/oz to $636.50/oz and silver falling $0.175/oz to close at $13.58/oz. Base metals were also mostly down on the day, with spot nickel prices showing the largest decline (-4.05%) while spot led putting in a positive result (+2.94%). Agriculture and softs were mixed with spot sugar putting in the largest advance (+1.45%), and spot ethanol showing the largest decline (-0.60%).

Overseas markets were up with the largest advances coming from Brazil's Bovespa index and Mexico's Bolsa index, up 2.26% and 1.77% respectively. France's CAC-40, Japan's Nikkei 225 and Germany's DAX indices also put in strong showings, up 1.41%, 1.39%, and 1.31%.

The positive surprise in 3Q GDP led to a broad based advance as all ten S&P 500 sectors were up on the day with energy leading the pack, up 2.86% on the day followed by the telecommunication and utility sectors, up 1.56% and 1.27% respectively. Today's advance in energy helped it become the second sector with a year-to-date (YTD) performance greater than 20%, with telecommunications representing the strongest sector with a YTD return of 26.46%.

Have a pleasant weekend,

Chris Puplava

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