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Second quarter GDP surprises to the upside; first quarter revised down

Increases in gross domestic product (GDP) is a measure of economic growth

Gross domestic product is what is referred to generally as “the economy.”  It is the sum of consumption, investment, and government spending. Another way to think of GDP is the output of goods and services produced by labor and property in the U.S. economy. This number is an estimate of growth. The U.S. economy is roughly $16 trillion.

GDPEnlarge Graph

The Bureau of Economic Analysis puts out three estimates of GDP growth after a quarter ends. The advance estimate is released within a month of quarter end, and is based on incomplete data or data subject to revision. The second is released after two months, and the third and final revision is released after three months.

Consumption is by far the biggest driver of GDP growth and accounts for something like 70% of GDP. The reason for the Fed’s quantitative easing program is targeted at consumption – if the Fed can lower mortgage rates enough that people can refinance, then they will have more disposable income and hopefully spend more. Investment is basically corporate investment in growth, also known as capital expenditures. Government spending is the final component.

Highlights of the Q2 release

The advance estimate of Q2 GDP showed GDP grew at an annualized pace of 1.7% between the first quarter of 2013 and the second quarter of 2013. Consumption grew 1.8%, while investment grew 9%. Government spending fell 0.4%. First quarter GDP was revised downward from 1.8% to 1.1%. This is quite the drop, especially considering the initial advance estimate for Q1 GDP was 2.5%. It makes one wonder what the Fed is looking at. The average GDP growth rate over the past three quarters has been close to 1%.

The price index increased at .07% annually, below Q1′s revised 1.3% pace.  This is still below the rate the Fed would like to see. The FOMC statement later that day referred to disinflation, or the fear that inflation may be too low.

The effect of government spending is igniting a political debate in Washington. Certain economists are in favor of having government spending increases in order to push economic growth. This is what is known as Keynsian stimulus spending – when the private sector won’t spend, the government can step in and pick up the slack. Politicians on the left will point to the effect decreasing government spending has had on GDP growth; politicians on the right will point out that government spending is roughly 24% of GDP, the highest since the Truman administration.

Implications for home builders

Home builders are sensitive to the general economy, particularly the job market. GDP growth of 1.7% should be enough to slowly heal the labor market and increase the capacity utilization numbers. Stronger consumption numbers are clearly a good sign for them. That said, this hasn’t been a rip-roaring recovery by any stretch of the imagination.

Overall increases in business activity and consumption is starting to drive more business for home builders, like Lennar (LEN), KB Homes (KBH), Toll Brothers (TOL), Meritage (MTH) and NVR. Housing starts have been so low for so long that there is some real pent-up demand that will become unleashed as the economy improves. The secular story for home builders is optimistic – household formation numbers will be a real wind at their backs.

Home building can become a real virtuous circle for the economy, and explains why the recovery has been tepid so far. Historically, home builders were the first to recover after a recession – construction and home building usually led the economy out of a recession. This time around, that didn’t happen because of shadow inventory, which meant that economic growth was more tepid during this recovery. That appears to be changing.