GDP beats but the market remains skeptical

It's old news by now, but today's Q4/18 GDP report came in a bit stronger than expected (+2.6% vs +2.2%), and growth for the calendar year 2018 (3.1%) was the strongest in more than a decade, and stronger than the 2.3% average annual growth rate of the current economic expansion. However, the market is acting like it thinks this may be the high-water mark for the foreseeable future. This is a show-me market, and so far the economic improvement we've seen under Trump's ministrations is less than spectacular, and certainly less than supply-siders (like me) would have expected to see given Trump's successes at rolling back regulatory burdens and slashing corporate income tax rates. But it is nevertheless progress.

Chart #1

Chart #1 shows the year-over-year growth in quarterly real GDP. Q1/15 actually holds the record for post-recession growth (+4.3%), but Trump apologists prefer to look at calendar-year growth since that puts last year in a more favorable light.

Chart #2

Chart #2 remains one of my most-favorite charts (and arguably a top Reader's Choice as well). You can cheer last year's 3.1% growth all you want, but from a historical perspective, it's only equal to the 40-year average growth rate that preceded the Great Recession. It's nice that the GDP "gap" suggested by the chart is no longer widening, but it's clear that things could be a whole lot better. We'll have to see more and better growth numbers in coming quarters before crowning Trump the King of Growth.
 

Chart #3

Chart #3 shows quarterly figures for real and nominal annualized GDP growth. The last quarter hardly stands out as unusual.

Chart #4

Chart #4 shows the year over year change in the quarterly GDP deflator, which is the broadest measure we have of economy-wide inflation. Last year inflation notched a 2.0% rate of growth, which is a bit higher than the 1.6% average for the past 10 years. But there is no obvious sign of inflation trending higher or lower than the Fed's preferred 2% rate. I'm always willing to be an inflation bull, however, especially during times when lots of political pressure is being put on the Fed to avoid being too tight with monetary policy. So I worry that inflation might trend a bit higher in coming years because the Fed will likely prefer to err on the side of caution and postpone rate hikes. But as with growth, we'll need to see more evidence before drawing firm conclusions.

Chart #5

In order for the economy to break out decisively from its "new-normal" 2+% growth rate since 2009, we'll need to see a pickup in business investment. Chart #5 shows one such measure: real gross private domestic investment registered an impressive 7.05% last year, which is substantially higher than its long-term trend of just over 4%. Still, there still appears to be a "gap" here that is sizable. Good news, but not yet in the nature of "winning."

Chart #6

Chart #6 updates another of my favorite charts. Here we see that the market's level of fear and uncertainty continues to edge downward as equity prices continue to edge higher. The market is climbing one of its biggest "walls of worry" in years, and it still has a bit to go before establishing new record prices. That's understandable, given that Trump's character is still under the microscope, trade agreements are still lacking, problems like N. Korea continue to worry, and we have yet to see convincing evidence that the economy is on its way to sustained, 3-4% rates of growth.

Chart #7

To emphasize my point that the market remains skeptical, I offer Chart #7. This compares the level of real yields on 5-yr TIPS (which arguably reflect the market's perception of the economy's real growth potential) to the 2-yr annualized growth rate of real GDP. Real yields do tend to track real growth, and that makes perfect sense. It's notable, therefore, that real yields have dropped by about 50 bps since late last year. This suggests to me that the market was much more optimistic about future growth a few months ago than it is now. Not surprisingly, the Fed is too. That is why nobody is projecting any meaningful rises in short-term rates for the foreseeable future. This chart suggests that the market expects real growth to average about 2.5%. That's ho-hum enough to keep the Fed—and the bulls—on the sidelines.

Chart #8

I'll close with an optimistic chart, since I remain optimistic that things will work for the better. Chart #8 is Bloomberg's weekly Consumer Comfort chart, and it shows a meaningful rebound in consumer sentiment in recent weeks. It's up an impressive 35% since just before the 2016 elections, and close to the all-time high of 66 which was reached in early 1999 under the Clinton administration.