Will Go-Go Growth Last?

The economy was on fire in the second quarter. According to the government, real annualized Gross Domestic Product (“GDP”) was 4.1 percent, the strongest quarter since Q3 2014, which came in at a sizzling 4.9 percent annual rate. As a reminder, GDP measures the nation’s total output of goods and services and is released by the Bureau of Economic Analysis (BEA) on a quarterly basis, with two subsequent monthly revisions to the advance estimate.

While GDP has become a quick way to measure the progress of the economy, it is just a broad brushstroke. The agency itself is exploring new data points "to provide a more complete picture of the distribution of economic growth and economic sustainability."

That said, GDP is still the standard for judging the pace of economic growth and in the second quarter of 2018, the results were undeniably strong and the catalyst appears to be a combination of factors, including: a jump in exports, as foreign buyers snapped up U.S. goods (i.e. soybeans) before tariffs were enacted; the recently enacted Republican tax cuts, which propelled business investment; an increase in consumer spending; and a bump up in government spending.

Will this go-go growth last throughout the year and beyond? Economists caution that we are likely to see a slower pace in the second half of the year, but for all of 2018, GDP is likely to expand by 3 percent. If so, that would be the best annual pace since 2005 and it also means that the second longest expansion on record has a shot of overtaking the longest one (1991-2001) a year from now.

Maybe you are like my octogenarian friend Mary, who when hearing about 3 percent growth, said "Big Deal!" My guess is that Mary recalls the halcyon days of growth in the early 1950s and early-to-mid 1960s, but in those years, the government was spending a ton of money on the Korean and Vietnam wars.

According to Bill McBride at Calculated Risk, "Other than the early period with a boost from military government spending, the growth in GDP has been tracking the growth in the labor force pretty well…if the labor force is growing quickly, GDP will be higher with the same gains in productivity. And the opposite is true." Over the past decade, not only did we have a massive recession, the economy has also had to endure a shrinking labor force, which is why growth in general has slowed down.

Whither housing? One part of the economy that is not participating in the good times is housing. In the Q2 GDP report, residential investment (new single family structures, multifamily structures, home improvement, broker's commissions, and a few other minor categories) decreased by a 1.1 percent annualized rate and existing home sales, which account for about 90 percent of the market, were down 2 percent in the first half of this year, compared to the same period in 2017.

Rising costs of construction and mortgage rates, coupled with limited supply, are the big problems for the housing market. Additionally, the surge in prices over the past couple of years has not been balanced by rising incomes and with mortgage rates higher, affordability is plummeting.

If the housing market slows, it could hurt a variety of housing-related products, such as furniture, kitchen products, paint or garden supplies. A softening in the housing market will slow (with a lag) retail purchases of those types of products.