Real GDP: Export-Led Growth, Weak Profits

Real GDP grew at a 3.3 percent annual rate in the second quarter led by gains in exports and government spending. Consumers, helped by the rebate, also contributed to real growth. Final sales have grown 2.4 percent over the past year with exports the strongest contributor. Profits, however, have declined over the past year.

U.S. Real Growth: Irony of Export-Led Growth

Second quarter growth reflected contributions from exports, government spending and consumer spending. Overall real domestic final sales came in solid and contributed to positive momentum going into the third quarter.

Trade and globalization have kept the U.S. economy in the growth column over the past year. During the second quarter, exports contributed one half of the gain in real GDP. Federal, as well as municipal government, spending has also contributed to growth. Consumers, spurred by the rebates, also contributed nicely to the gain.

Going forward, growth is likely to be narrowly focused, however, with most of the improvement coming from net exports and federal spending. Our expectation is that consumer spending and business investment will be sub-par for the second half of this year.

Consumer Spending: Still Struggling

Real personal consumption expenditures grew at a sub-par 1.7 percent during the second quarter compared to growth of 2.8 percent for all 2007. As expected, much of the slowdown is reflected in durable spending. The impact of the stimulus is still evident in the figures but it appears to have been concentrated in nondurable goods. Spending for nondurable goods rose at a 4.2 percent annual rate, while spending on big-ticket items fell at a 2.5 percent pace. Services outlays also packed much less punch, rising at just a 1.3 percent annual rate compared to 2.6 percent last year.

Residential construction declined at a 15.7 percent pace in the second quarter, following declines of 25 percent plus in the prior two quarters. Equipment & software spending has declined in the first half of this year compared to a gain of two percent last year. On net, domestic private demand remains weak due to export-led growth.

Profit Weakness: Classic Late Cycle/Recession Pattern

Corporate profits declined in the second quarter, repeating the weakness of the last three quarters. This pattern is consistent with the fundamentals. Top-line revenue growth has slowed as suggested by weaker domestic final sales. Meanwhile, higher producer prices, especially energy, suggest that input costs have risen and thereby squeezed corporate profits on the cost side.

Weaker profits feed into the economy through their incentive impacts on hiring and business investment. Weaker profits are consistent with job losses and a slowdown in business investment. On the income side, weaker profits are associated with lower dividends and capital gains which negatively impact consumer income. Meanwhile, profit losses mean reduced federal and state income tax revenues.

Wachovia Corporation
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