While third-quarter economic growth came in below expectations, held back by the Delta surge and major supply-chain issues, we see solid underpinnings for the economy that should support further profit growth and ultimately stock prices.

Leading economic indicators remain encouraging, consumers are very healthy with pent-up demand, and the labor market continues to show improvement. Meanwhile, corporate profits continue to come in much better than expected.

Moving from V-Rebound to Sustainable Economic Growth: Ever since the economy reopened after last spring’s hard lockdown ended, we have experienced a very strong snapback in economic activity. This V-shaped recovery, supported by massive fiscal stimulus, very easy monetary policy, and the unleashing of significant pent-up demand, is transitioning toward more normalized, sustainable economic growth.

Last week’s GDP report showed third-quarter economic growth coming in at 2.0%—below expectations and the smallest gain in this recovery. The deceleration reflects a confluence of factors, including waning fiscal stimulus (e.g., the expiration of unemployment benefits), a surge in the Delta wave over the summer months, which weighed on consumer spending, and supply-chain problems, which hampered production and trade flows. However, the internals of the report remain encouraging.

Importantly, consumer spending remains a positive and came in better than expected and continues to show the handoff from goods spending (COVID beneficiaries) to services spending (reopening beneficiaries). Service spending rose at a 4.7% rate, helped by restaurants, despite Delta’s impact on services. Meanwhile, a lack of auto inventories, a victim of supply-chain issues, hurt goods spending which declined 0.3%. We expect the transition from goods spending (including furniture and electronics) to service spending (including airlines, hotels, and restaurants) to continue as the pandemic fades—to the benefit of service sector stocks.

Major Reasons for a Positive Economic Outlook: Despite being past peak economic growth, we remain optimistic on the economic outlook. Although still a risk, COVID cases and deaths are now subsiding. This should help the handoff to the service economy and help with supply-chain bottlenecks. Consumers remain in great shape with low debt levels, significant excess savings, and record net worth. These are important attributes for a consumption driven economy like the U.S.

In addition, banks are healthy, as evidenced by recent earnings reports from the major banks. Corporate balance sheets are strong and business confidence is high. This should support higher corporate expenditures and future hiring. Indeed, other data points from last week support this narrative of a healthy economy and bright outlook.

State Indexes Show Continued Broad-Based Expansion: The Philly Fed State Coincident Indexes showed activity increased in 46 states in September and decreased in four states. In addition, the average monthly percent change across all 50 states was 0.6%, three times the historical average, reflecting above-trend growth. Similarly, the U.S. Coincident Index, using the same methodology as the state indexes, advanced 0.4%, double its historical average. It also rose 5.8% year/year, a deceleration from the peak rate in April, but still near the fastest pace since 1984, indicating a continued robust expansion.

Labor Market Indicators Remain Encouraging: Initial claims for unemployment insurance fell 10,000 last week, its fifth consecutive decline, to 281,000—a new pandemic low. Similarly, continuing claims and the insured jobless rate also fell to their lowest levels since March 2020. The steady decline in initial and continuing claims reflects the ongoing improvement in labor market conditions—a critical element for a healthy economy.

Corporate Profits Continue Exceeding Expectations: Through the first three weeks of earnings season, with 279 companies having reported results, third-quarter earnings are projected to be 7.4% ahead of the 27% consensus estimate at the start of earnings season. Though it will fall short of the historically high beat-rates of the previous five quarters, this quarter is on track to top the maximum 6% beat recorded from 2012 through 2019. These strong earnings results continue to provide significant support for stocks.


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