<

Why markets have shrugged off the 1st quarter economic revision

Increases in gross domestic product, or GDP, measure economic growth

Gross domestic product is what’s referred to generally as “the economy.” It’s 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 it’s 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.

Highlights of the Q1 release

The final revision to Q1 GDP showed GDP contracted at an annualized pace of 2.9%. The advance estimate was a +0.1% increase, which was revised down to -1% and then finally settled at -2.9%. The price index increased at 1.3% annually. This is still below the rate the Fed would like to see. Personal consumption expenditures were disappointing, at 1%. While weather undoubtedly played a role in the number, one wonders whether the introduction of the Affordable Care Act (AKA Obamacare) had anything to do with the lousy print. For what it’s worth, healthcare spending was revised downward, but that could be a technical correction that has no real economic impact.

Implications for homebuilders

Homebuilders are sensitive to the general economy, particularly the job market. Luckily, the lousy GDP report seems to be an outlier, and if you look at other data, like the Markit PMI data that came out today, the economy seems to be picking up steam. The bond market rallied small on the GDP report, but the increase was small enough to signal that investors put a big asterisk next to the number.

Overall increases in business activity and consumption are starting to drive more business for homebuilders, like Lennar (LEN), Pulte Group (PHM), Toll Brothers (TOL), and D.R. Horton (DHI). Housing starts have been so low for so long that there’s some real pent-up demand that will unleash as the economy improves. The secular (long-term) story for homebuilders is optimistic. Household formation numbers will be a real wind at their backs. Investors who are interested in trading the builders as a sector should look at the S&P SPDR Homebuilder ETF (XHB).

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

The Realist Discussions