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US: Better-than-expected 2Q 09 contraction, 3Q 09 to show positive growth
August 7, 2009

2009 second quarter GDP figures have come in better-than-expected, and a positive growth figure will likely emerge in the third quarter of this year. We expect consensus earnings to be revised upwards, which will be a driver for the US stock market.


Author : iFAST Research Team



Untitled Document
Chart 1:
 
 

Key Points

  • Better-than-expected 1.0% quarter-on-quarter annualised GDP contraction in 2Q 09 for the US economy
  • 1Q 09 GDP contraction was worse than previously forecast at -6.4%, compared to advanced estimate of -6.1%
  • Consumption remained weak, inventory levels declined yet again
  • We reiterate that the US economy will grow in 3Q 09, albeit with assistance from inventory restocking
  • Housing market showing signs of stability, which may be a boost for consumption
  • Most companies have reported earnings for 2Q 09 which have exceeded forecasts, and corresponding upward earnings revisions are likely
  • We are revising up earnings estimates, but not by too much

Better-than-expected contraction, helped by a downward revision in 1Q 09 GDP

Recent data from the Bureau of Economic Analysis showed a 1.0% quarter-on-quarter annualised decline in 2Q 09 GDP. This was better than the 1.5% decline expected by the consensus, but was aided by the downward revision of 1Q 09 GDP. Without this downward revision, 2Q 09 GDP was only slightly above expectations. The 6.4% quarter-on-quarter annualised contraction in 1Q 09 was the worst since 1982, revised from the advanced estimate of a 6.1% decline. This provided a lower base for a comparison with 2Q 09 GDP, which led to a better-than-expected 1.0% quarter-on-quarter annualised contraction.

Table 1: GDP Components (Annualised quarter-on-quarter change in %)
 
1Q 09
2Q 09*
3Q 09**
4Q 09**
FY2009 (y-o-y)**

Gross domestic product

-6.4 -1.0 2.8 1.6 -2.5

Personal consumption expenditures

0.6 -1.2 0.8 1.5 -0.9

Gross private domestic investment

-50.5 -20.4 40.0 3.5 -21.5

Exports

-29.9 -7.0 -1.5 5.5 -13.0

Imports

-36.4 -15.1 9.0 4.5 -15.7

Government consumption expenditures and gross investment

-2.6 5.6 0.5 0.5 1.5
Source: US Bureau of Economic Analysis, * denotes official advanced estimate, ** 3Q, 4Q and FY 2009 figures are iFAST estimates

Consumption, investment under pressure, net exports and government spending lift GDP

Personal consumption, a significant part of the US economy, slumped 1.2% on a quarter-on-quarter annualised basis, while gross private domestic investment declined 20.4%, weighed down by weakness in residential fixed investment, further declines in inventory and a general reluctance by businesses to spend on varying items like equipment and software.

On the other hand, a 5.6% annualised quarter-on-quarter increase in government spending resulted in a positive contribution towards GDP, suggesting that much anticipated government spending measures are finally making some impact on overall growth. Net exports also contributed positively for the third straight quarter, aided by weakness in the US dollar as well as lowered levels of imports.

US economy to grow again in 3Q 09

We had earlier suggested that the US economy would show positive growth in the third quarter of this year (see “US Economic Growth may return in 3Q 2009”), and it now appears that this situation will very likely materialise. Private inventories declined by US$141.1 billion (in chained 2005 dollars) in 2Q 09, the largest quarterly decline since records began in 1994, after declining by US$113.9 billion in 1Q 09. Since GDP growth is measured by quarter-on-quarter changes, any decline in inventories by less than US$141.1 billion in 3Q 09 would be a positive contribution to overall GDP.

Various measures like the US PMI (Purchasing Managers Index) and corporate news releases suggest that inventory draw-down is almost done and possible restocking is taking place. Thus, we are not expecting private inventory levels to decline by much further in 3Q 09 and we could even see a long-awaited build of inventory which will provide a huge boost to GDP. Hence, our quarter-on-quarter annualised estimate for 3Q 09 growth is relatively high at 2.8%. We also expect that the worst of the business cycle slump has already been seen in 2Q 09, and business investments will rebound sharply in 3Q 09.

Signs of improvement in the US housing market

The impact of declining home prices in the US has evidently taken a toll on consumption. Chart 1 shows the close relation between changes in personal consumption and home prices (as measured by the S&P/Case-Shiller home price index). This intuitively makes sense, as a wealth effect develops when home prices rise which increases the tendency for homeowners to spend. Also, the ability to take out a second mortgage on one’s home as prices rose early this decade fuelled the spending ability of the US consumer.

Most market watchers thus pay close attention to the US housing market, which has seen no end of bad news, until recently with several positive indications arising. Since home prices first started falling in 2006, the S&P/Case-Shiller home price index has seen 33 consecutive month-on-month declines, until May 2009, where the index posted a 0.5% gain from April. While not a highly significant increase, the broad-based nature of price increases (15 out of the 20 areas surveyed showed flat or rising home prices), as well as a break in the declining trend are clearly indicative of stability returning to the US housing market.

Existing home sales rose 3.6% month-on-month in June, the third consecutive month of increasing sales, while new home sales spiked 11% from May levels, further supporting a view that the US housing recovery is underway. While a recovery for the housing market is likely to be long and arduous, we believe that a return of stability in this crucial area of the US economy has far-reaching positive implications, like more certainty over mortgage asset values as well as a likely improvement in consumer spending. 

Corporate Earnings better-than-expected

As of 1 August 2009, 353 of the 500 companies in the S&P 500 have reported 2Q 09 earnings. According to Bloomberg’s data, 74.5% of the companies which have reported beat consensus estimates, with 8.5% reporting results in-line with consensus forecasts. The large percentage of better-than-expected results suggests that the consensus is “looking too low”, and we expect upward revisions in earnings to follow.

In our previous update (US Corporate earnings to bottom out in 2009), we suggested that forward earnings revisions were a key risk. It now appears that the consensus may have overestimated the severity of the recession on corporate earnings, which means that earnings revisions may be made upwards, making revisions more of a potential stock market driver, instead of a key risk.

Revising up consensus earnings estimates, but not by too much

As at 31 July 2009, the consensus expects companies in the S&P 500 to achieve earnings growth of 22.2% in 2010 and 21.2% in 2011, after a 15.1% decline in earnings this year. Many companies have successfully slashed costs in the downturn and have reported better-than-expected profits in 2009 thus far. We are thus revising up consensus S&P 500 EPS estimates for 2009, 2010 and 2011 (see Table 2).

Table 2: Earnings Estimates for S&P 500
EPS Estimates 2009 2010 2011
Consensus 55.7 68.1 82.5
Revised* 60.2 71.5 86.6
Earnings Growth -8.4% 28.3% 27.2%
Estimated PE 16.4X 13.8X 11.4X
Source: Bloomberg, *iFAST Compilations and estimates, as at 31 July 2009

While we believe that analysts are beginning to revise up earnings forecasts for the respective companies they cover, we are not expecting huge revisions for the US market, unlike the more cyclical Asian markets. Since the subprime crisis first erupted, the consensus has been focusing on the operating earnings of US companies (which are more stable, and easier to forecast) as opposed to pure net income (which takes into account extraordinary profit and losses).

We have thus applied an 8% premium to consensus 2009 operating EPS (to factor in successful cost-cutting measures as well as the better-than-expected 2Q results), and a 5% premium to 2010 and 2011 EPS estimates. As at 31 July 2009, the S&P 500 trades at a forward PE of 13.8X and 11.4X based on our revised earnings estimates for 2010 and 2011 respectively. We maintain a 4.0 star “attractive” rating on the US equity market.

 

 


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