Broker Check

Second Quarter Economic Growth

| August 01, 2019
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The stock market responded positively to the US second quarter economic growth rate. According to the Bureau of Economic Analysis, the US economy grew 2.1% in the second quarter of 2019. This has been called the Goldilocks number as it is not too hot and not too cold to upset either the stock or bond market. The 2.1% growth rate is hot enough that it exceeds the average economist expectation of 1.8% growth. Meanwhile, the number is just cold enough that it does not upset the expectations that the Federal Reserve will cut short-term interest rates by one-quarter of a percent in late July.

Highlights of the report include a 4.3% increase in personal consumption expenditure. This is basically a measure of household spending. The strong growth rate shows that US households continue to spend which confirms expectations given the strong labor market and high levels of consumer confidence. It is also a bounce back from an average growth rate of just 1.25% in household spending over the preceding six months.

Government spending was also strong in the second quarter, increasing 5.0%. This is largely due to a 7.9% increase in federal government spending with state and local governments reporting a more moderate increase in spending. This is the largest increase in government spending in over a decade.

Meanwhile, domestic investment decreased by 5.5% in the second quarter largely due to a sharp decline in investment in non-residential structures. However, this category has a tendency to be highly volatile from quarter to quarter. Investment in residential structures also declined but by a more moderate rate of just 1.5%. This represents the sixth consecutive quarter of declining investment in residential structures which may be a continued negative sign for the US housing market.

The trade war also had a negative impact on US economic growth in the second quarter. US exports declined by 5.2% while imports increased just 0.1%. This may be a sign that trade barriers are making it more difficult for US companies to sell their goods and services to foreign businesses and consumers.

The bottom line is that US economic growth has slowed. However, the pace of the decline has been slow enough that it has not spooked the stock market and will likely cause the Federal Reserve to stay the course and cut interest rates this month.

The slowing rate of economic growth has been reflected in lower stock returns. While the stock market has posted strong returns this year the gains have largely offset the losses form the fourth quarter 2018. A longer-term view shows that stocks, as measured by the S&P 500 Index, have increased just 7% in the past 18 months and only 4% since the end of the third quarter 2018. While this still represents an increase in stock prices the pace of the increase has slowed substantially recently.

Meanwhile, the US bond market returned over 7% over the past 18 months and 8.14% since the end of the third quarter 2018. In other words, the bond market, as measured by the Barclays Aggregate Bond Index, has outperformed stocks as investors have increasingly favored lower risk assets as the rate of economic and earnings growth has slowed.

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