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Cheap Energy is Powering GDP Growth

Written By Briton Ryle

Posted November 26, 2014

The economy’s revised report card came out yesterday, taking everyone by surprise. The U.S. Department of Commerce’s Bureau of Economic Analysis reported much better GDP growth for Q3 in yesterday’s second estimate than it had reported in last month’s first estimate.

October’s first estimate had itself taken everyone by surprise when Q3 GDP was reported to have growth at an annualized rate of 3.5%. Yesterday’s second estimate poured even more syrup on top of that, upping Q3’s GDP growth to an annualized rate of 3.9%. The report then put the cherry on top of our GDP sundae by revising Q2’s GDP growth up to an annualized rate of 4.6% from the previous 4.2% estimate.

But is the economy really as great as all that? Even with all the stellar jobs reports this year, there are still nearly 9 million persons unemployed, or 6.5% of the employable population. What is more, wages still aren’t growing, and you can’t have a sustainable recovery without wage growth, as you simply end up stagnating.

Experts are telling investors in U.S. markets to rest assured, the current spurt in GDP growth is no false start, with GDP expected to continue growing with gusto above 3% next year as well.

Though it is true that we do not have some of the requisites needed to keep growth alive – such as rising wages which fuels consumer spending – the U.S. economy does have other things going for it that are filling that void.

Fears of Underlying Weakness

The reason these last couple of better-than-expected Q3 GDP estimates have taken so many by surprise goes all the way back to Q1 and the cold snap that ruined it. With higher heating and fuel costs eating away at consumers’ budgets, not to mention the deep freeze keeping people in their homes and away from the shopping malls, consumer spending suffered at the start of the year, with GDP growth actually contracting 2.1% in Q1.

This added a good deal of concern in the markets, for if Q2’s GDP change was also negative, it would officially put the U.S. economy back into recession on two consecutive quarters of GDP shrinkage. Needless to say the markets were both surprised and relieved to see a huge Q2 GDP growth of 4.2%, which was just yesterday revised to 4.6%.

Yet Q2’s stellar growth was still not enough to convince everyone that the underlying economy was genuinely strong. The sceptics simply attributed the strong Q2 reading to postponed purchases that were skipped during Q1 and pushed into Q2. They figured Q3’s GDP figures would return to near 2%.

Their reasoning? All year long inflation has been rising each month at an annualized rate of 2%, while wages are still stagnant. This means consumers will gradually spend less and less as their purchasing power is eroded by rising prices, with no wage increases to replenish that loss in buying power.

But oh what a difference a few months make. The picture we have now of the underlying economy is very, very different. And much of that is due to fuel.

Fuel Fills the Wage Void

Despite stagnant wages and unemployment still remaining elevated at 6.5%, consumers still managed to increase their spending:

“Real gross domestic purchases – purchases by U.S. residents of goods and services wherever produced – increased 3.0 percent in the third quarter,” yesterday’s BEA report revealed. “Real personal consumption expenditures increased 2.2 percent… Durable goods increased 8.7 percent… Nondurable goods increased 2.2 percent… Services increased 1.2 percent…”

And yet, such increases in consumer spending came despite continuing rising prices:

“The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 1.4 percent in the third quarter,” the report showed. “Excluding food and energy prices, the price index for gross domestic purchases increased 1.6 percent…”

How is that possible? How are consumers able to increase their spending despite higher prices and stagnant wages?

Because of one very important change… a drop in energy prices. Over the past five months the national average price of a gallon of gasoline has fallen some 23.64% from $3.68 at the end of June to $2.81 yesterday.

Mark Zandi, Chief Economist at Moody’s Analytics, expects “lower oil and gasoline prices… to provide some juice” to the economy in the near term. “That’s like a big tax cut to consumers, and I expect that to help propel consumer spending through the holiday buying season and into next year.”

So while we still aren’t seeing wages rising faster than inflation, we can still expect consumer spending to remain strong at least over the near term as fuel prices remain low, leaving consumers with more money in their pockets… which won’t remain in their pockets for long but will be spent fuelling the economy.

But what about the longer term? Fuel prices can’t remain this low forever. What will happen to consumer spending and GDP growth when fuel starts to rise again?

“At the current rate of growth,” Zandi answers, “we’re creating so many jobs that a year from now, certainly two years from now, we’ll have absorbed all those unemployed and under employed. We will see stronger wage growth and that will kick the economy into an even higher gear. That will be the fodder for more consumer spending going forward. We’re not quite there yet, but we’re getting close.”

So the growth of the U.S. economy is pretty much covered, both over the near term (with the help of low fuel prices to fill the void of stagnant wages), as well as over the longer term (with steady job growth averaging +200,000 per month ultimately empowering more people to spend).

What is more, “the quality of the job growth is much improved,” Zandi adds. “We were seeing a lot of low paying jobs, but now we’re seeing high paying and middle paying jobs. I do expect wage growth to kick-in.”

A Refuge from the Global Storm

Investors need not quake in the face of the still troubled global economic recovery, with Japan officially falling into recession earlier this month, Europe losing its battle against deflation, and China slowing to its slowest growth rate in a decade. Despite the gloom all around, America is still shining bright like a lighthouse guiding all ships to take refuge in her ports.

U.S. GDP is surprising everyone with its resilience, and consumerism is thriving despite high unemployment and stagnant wages. For the time being, low fuel costs are filling the purchasing power void left by stagnant wages. In a year or two, the steady stream of new job creation and higher wages will fill the purchasing power void left when fuel prices rise back up to normal levels.

Investors thus have some very clear signals to stay invested in the U.S. economy. In fact, we can expect investment-refugees from other battered economies to increase their investments in America, adding even more lift to U.S. equity values.

The place to be invested is here. The time to be invested is now.

Joseph Cafariello