The Data Keep Surpassing Expectations -- and Will Continue To

Second quarter real GDP growth was reported at an annual rate of 3.3%, up from the originally reported 1.9% rate in the advance report.

The bears (mostly those who have been consistently wrong by forecasting a decline in first quarter real GDP and then again for second quarter) quickly claimed that this figure was aberrant and that the third and fourth quarter would finally produce the weakness they have so bombastically forecast again and again.

Naturally, these were the economists that received the most attention from the press, which refuses to believe that the U.S. economy could actually be growing.

The bears will be (very) wrong once again.

The trends in the second quarter data suggest that third quarter real GDP will post an annualized increase of about 2.5%, and possibly as much as 4%.

Net exports for the third quarter will add about 2% to the GDP number. And yes -- exports do count. The fact that it is not domestic demand means nothing to the companies receiving the orders.

Consumer spending (real personal consumption expenditures) will rise at a modest pace in the third quarter, but will again be positive. Business investment in structures, and for software and equipment will also add to the GDP gain. Government spending could well be flat.

Residential construction should subtract even less than the 0.6% it did from the second quarter real GDP number. It will again be the only major component of GDP to decline.

Most noteworthy, however, is that inventories could swing sharply to a positive contribution. The decline in the second quarter was due to higher commodity prices. That produced a negative inventory valuation adjustment. The downtrend in the third quarter will reverse that, and a positive inventory valuation adjustment could lead to a large gain. For now, our forecast assumes only a small inventory benefit, but there is substantial upside potential.

Perhaps a second straight quarter of a real GDP gain near 3% will finally put an end to the incessant overly bearish economic views that are so fashionable. There is too much deductive reasoning: "everyone knows this is a recession, and it certainly feels like one, so the data must be wrong, or not yet reflecting reality." But those opinions can't continue in the face of persistent facts.

Inductive reasoning, which is the basis of rational thought and scientific reasoning, starts with the facts and then comes to the conclusion. And the facts clearly show that the U.S. economy is slogging along with surprisingly decent growth.

For more on the GDP data and our Q3 forecast, please click here.

For a discussion of how this business cycle is best understood as a severe housing correction, but not a consumer recession or a credit crunch, please see the August 18 Big Picture column.

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