Economy still on crutches, but making job gains

INDICATOR: Second Quarter GDP/ADP July Jobs Estimate

KEY DATA: GDP: +1.7%; Consumption: +1.8%; Investment: +9%/ADP: 200,000

IN A NUTSHELL: "While the economy limps along, job gains seem to be holding up quite well."

WHAT IT MEANS: The first reading of the state of the economy during the spring was released today and it came in above consensus. Most people expected growth in the 1% range (I was at 2%) so this looks like a good number. Before we get to any analysis, though, it must be noted that the government revised the data back to 1929, adding new accounting methods, data sources and statistical adjustments. Thus, history as we knew it has changed a bit. For example, first quarter growth, which had been estimated at 1.8%, is now just 1.1% while the fourth quarter of 2012 was revised down to just 0.1% from 0.4%. In other words, the last three quarters we have had growth rates of 0.1%, 1.1% and 1.8%. That is a nice upward trend but no growth level could be considered decent let alone strong. In the spring, consumers held up their end by buying lots of goods but not much services. Since services are roughly 45% of the entire economy, that is a problem. Housing also added greatly to growth. Businesses invested heavily in everything, a sign that maybe conditions are better than is being indicated in this report. Growing inventories probably mean businesses are expecting stronger growth ahead. Exports accelerated but so did imports so the trade deficit widened, slowing growth. And, as usual, the federal government did all it could to slow growth by cutting spending again. In contrast, state and local government purchases rose, the first increase in four years. Inflation is largely non-existent with consumer prices flat.

While the economy limps along, job gains seem to be holding up. ADP estimates that the 200,000 per month job increase we have been seeing over the past year should be sustained in July. The gains look to be spread across all sizes of firms and just about every industry except manufacturing.

MARKETS AND FED POLICY IMPLICATIONS: While this is a better than expected report, it isn't very strong. If you look at the past three quarters, the economy has not done very much. That is the economic environment facing the Fed as it meets today. It is clear that many members want to taper or even end quantitative easing as soon as possible. This report doesn't provide the economic basis to do that especially since housing has added so much to growth recently and higher rates could lead to a moderation in activity. In addition, the government's official estimates of July jobs comes out on Friday and while it is likely to be in the 200,000 range, the unemployment rate will still be around 7.5%. But QE has to start ending eventually. The only issue is whether tapering begins soon, such as in September, or later, such as December. That is a pretty narrow time frame and the markets recognize that and are behaving accordingly. As for the equity markets, this report shouldn't buoy any hopes about the economy but who knows? Nothing seems to get in the way of investors' desire to buy stocks right now.