On Wednesday morning, the U.S. Bureau of Economic Analysis (BEA) released its first estimate for second-quarter GDP. The data came at +4 percent, which was better than analyst expectations of +3.2 percent. However, the reader should note that the first estimate is just that — and that we will see this number revised several times in the next few months, and even quarters and years.
In addition to this strong data, the BEA announced that the first-quarter wasn’t as bad as expected, with GDP falling just 2.1 percent versus the initial estimate of a decline of 2.9 percent, and second half 2013 data showed a slight improvement as well. While preliminary this is generally good news, and it suggests that the U.S. economy probably isn’t in a recession, investors should note that in the first-quarter GDP grew at 0.9 percent, which is mediocre.
Investors didn’t really react to the news. While stock futures popped slightly immediately after the news, they immediately gave up these gains. Treasury bonds and gold fell slightly, suggesting that traders are betting against safe havens on the belief that the U.S. economy is improving.
As an investor, your first reaction might be that this is good news, and a reason to buy stocks and economically sensitive stocks in particular. However, such causality is an overly simplistic way of looking at things, and there are three reasons for this.
First, investors should consider that the stock market climbed in the first part of the year despite the fact that Q1 GDP is negative. If negative GDP isn’t necessarily negative for stocks, then positive GDP isn’t necessarily positive for stocks. This doesn’t mean that stocks should fall on the news, rather that we cannot really correlate the two. Second, GDP data is backward-looking whereas stocks tend to be forward-looking. Investors don’t buy stocks because the underlying companies have performed well, but rather because they believe that the future of these companies is brighter than the past.
Finally, if you look at the companies in the S&P 500, they are international companies, and the fact that they are American means little more than that they are headquartered here. With very few exceptions, companies that are large enough to be in the S&P 500 are multi-nationals. Strong U.S. GDP data isn’t bad for multinationals, but its impact is limited.
Given these points, I wouldn’t take buy or sell cues from the BEA’s GDP data. What investors should be looking at instead is the Federal Reserve’s monetary policy. As the Fed winds down its quantitative easing program, look for stocks to top out and begin to roll over. Since quantitative easing became a commonplace policy for the Fed, stocks have risen during periods of quantitative easing, and they have fallen as the proverbial punch bowl has been taken away, as evidenced by the severe corrections we saw in 2010 and in 2011.
Investors should note that during 2013 when quantitative easing was ongoing and at its fastest pace since the financial crisis that stocks performed exceptionally well, and in 2014 as this policy has wound down that stocks have risen more modestly. If the Fed really intends to end its quantitative easing program in October then investors should prepare for a correction over the next couple of months in spite of the strong GDP data.