This is one of those days when the news flow all around us is favorable. European leaders have finally come out with a credible enough plan to tackle the issues plaguing the common market. On the home front, we got the best news on the economic growth front with the third quarter GDP report. And we continue to get reassuring earnings reports.
We will discuss the Euro-zone deal a bit later, but let provide a quick take on this morning’s third quarter GDP report. Real GDP growth accelerated to 2.5% rate in third quarter, broadly in-line with expectations, but up from the previous quarter’s 1.3% pace. The positive headline number aside, the report’s internals are very favorable as well.
Driving the acceleration is consumer spending, with continued momentum in business investments and some positive contribution from international trade. Inventory investment was a modest drag on growth, which is positive for the coming quarters. Government spending was flat, with federal up and state/local down.
Consumer spending increased at a better than expected 2.4% rate in the quarter, up from 0.7% in the second quarter. Business spending also increased at a nice clip, with non-residential fixed investment increasing by 16.3% after gaining by 10.3% in the preceding quarter. With inventory investments modestly down, real final sales, which is GDP less inventories, increased at 3.6% compared to a 1.6% gain in the second quarter.
Today’s GDP report confirms the favorable economic readings of the last few weeks that had helped bring down some of the more exaggerated recessionary fears. This is not a great report, but it nevertheless represents a significant improvement from where expectations were just a few weeks back. With the European story expected to become less of a drag going forward following the last night deal, we have the makings of a nice market rally into the final months of the year.
The Euro-zone Agreement
The agreement provides for a 50% ‘voluntary’ haircut for private-sector holders of Greek government bonds, requires €106 billion in additional bank capital, and increasing the buying power of the rescue fund to about €1 trillion. The plan provides for forestalling the spread of contagion to other at-risk nations such as Spain and Italy by strengthening the Euro-zone rescue fund (EFSF) through two parallel methods.
In the first method, the fund will provide for indirect guarantees by covering initial losses on Spanish and Italian government bonds. The other method provides for the setting up of a separate fund that will be seeded with capital from the EFSF, but will also have participation from other non-EU nations, such as China. The head of EFSF is visiting China today specifically for that purpose, with active lobbying from Euro-zone leaders, particularly France’s Sarkozy.
These are all good big-picture goals, but the agreement does not provide for a number of key details, at least not at this stage. For example, we don’t know where the additional bank capital is going to come from. We also don’t know at this stage the extent of private sector participation in the plan, given the heavy haircut, though an influential bank lobby group negotiated on the banks’ behalf and agreed to the haircut provision.
Notwithstanding the lack of details, the plan does provide for a viable-enough roadmap to address the issues plaguing the common currency. Importantly, by addressing all the outstanding issues simultaneously, the plan helps bring down the global contagion risk that had been weighing on the markets for a while now.
On the earnings front, Exxon (XOM) modestly came ahead of expectations, while Proctor & Gamble (PG) met EPS expectations on better than expected revenue numbers. Visa (V) came out with an EPS beat after the close on Wednesday, but it missed revenue expectations.
Pending Home Sales is scheduled for release today at 10:00 AM EST, and is expected to decrease by 0.2% after decreasing by 1.2% in August to 88.6.
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