On Friday we learned that the economy grew at a measly 1.2% rate during the 2nd quarter, about half of what most economists were expecting. Worse, growth figures for the previous two quarters were lowered as well.
The economy supposedly expanded at a 0.8% rate during the first quarter of 2016 (revised downward from 1.1%), and at a 0.9% rate during the fourth quarter of 2015 (revised downward from 1.4%). But here’s the kicker: this means that over the past year, the economy has only grown by 1.2%.
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For awhile now, nearly everyone has assumed we’ve been in a 2% economy. No one was enamored, but at least it was sustained growth. Now, with the economy having expanded 1.2% over the last 12 months, and at a 1.2% rate over the last 3 months, it would appear things are worse than previously thought.
So what’s causing the tepid growth? And does this mean we could be heading toward recession?
A deeper look into the GDP report reveals one primary pocket of strength and one primary area of weakness.
The strength is stemming from the resilience of the U.S. consumer. Consumer spending accounts for roughly 68% of the economy, and it grew at a 4.2% nominal rate during the second quarter. At face value, that presents a relatively good picture of strength and stability for the U.S. economy.
But unfortunately, robust consumer spending continues to be offset by weak business spending.
Real Gross Private Domestic Investment (economist talk for business spending) fell for the second consecutive quarter, as seen in the chart blow.
The decline took the year-over-year growth rate into negative territory for the first time since the great recession. Is this worrisome? To put it plainly, yes.
Consumer spending may account for the bulk of the economy, but counterintuitively, it is business spending (or the lack thereof) that frequently leads the economy into recession. This becomes evident when you look at a long-term chart of business spending.
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Notice below that the year-over-year change in business spending has a strong tendency to drop below zero just before or in sync with, the onset of a recession. In fact, declining business spending has been a major factor in each of the last eleven recessions. These areas are marked with red circles.
To be fair, I should point out that declining business spending is not always followed by a recession. The “false positives,” so to speak, are marked on the chart in green.
But the message is clear: when businesses pull back, it adversely impacts the economy. Even if we don’t see a recession accompany this dip, it’s still not a good sign for broader business conditions.
Analysts expect to see a rebound in the latter half of the year, but other indicators suggest we may not. Take last week’s durable goods report as an example. June orders sank 4%, the biggest drop in almost two years.
And with oil and commodities resuming their downward trends, it’s unlikely that the beleaguered energy and materials companies will begin spending anytime soon.
Here’s a chart showing the recent downward momentum in oil. Prices are down roughly 20% over the last two months, with the price of oil resting just above its 200-day moving average.
It’s the same story with the rest of the commodity complex. In this next chart, we see the CRB Commodities Index once again in freefall. There is strong support near the 178 area, which coincides with the 200-day moving average.
A drop below these levels could spur additional technical weakness, prompting prices to fall further.
The other issue at hand regarding business spending has to do with uncertainty regarding the election. Businesses hate operating under uncertainty and have a tendency to refrain from making major investment decisions when the path forward is unclear.
This could result in a back half of the year where businesses are paralyzed into inaction, as they wait and watch how things develop. In the meantime, they’ll probably continue to opt for dividend hikes and share repurchase programs. This can be good for stocks, but not for the economy.
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