Wednesday, November 29, 2006

Unexpectedly Bullish U.S. GDP Report

The revised third quarter U.S. GDP report was a lot stronger than the first one. And here I am not primarily refering to the increase in the headline number from 1.6% to 2.2%.

What was most surprising was the fact that corporate profits rose. Not just compared to last year's Katrina-depressed levels but also compared to the previous quarter. I had expected , just like for example Paul Kasriel of Northern Trust, that they would fall.

The reason we were wrong, were however not faulty analysis, but faulty preliminary data. The preliminary data underestimated GDP growth and even more so national income growth, while greatly overestimating compensation of labor, which were downwardly revised by more than $100 billion. Had the government's initial data on GDP and compensation of labor been unchanged, corporate profits would have fallen significantly instead of rising.

This revised picture paints a lot more bullish outlook. The higher corporate profits will mean that business investments is likely to be stronger than otherwise. Yesterday's durable goods report suggested a downturn in business investments, but the stronger profits means the chanse of a turn around has increased.

Still, there were details supporting the bearish case even in this report. While the dramatic downward revision in labor income enabled a increase in corporate profits, it also means that the household savings rate is a lot lower, -1.3% rather than the -0.5% previously reported. And as more than half of the upward revision in GDP comes from larger inventories, this means that production could be reduced in the fourth quarter 2006 or in 2007.

All told, most signs still indicates that a recession in 2007 is more likely than not. But the strength of corporate profits in this reports means that the probability of a "soft landing" have increased somewhat.


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