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US: 1Q 10 GDP - The consumer awakens!
May 6, 2010

The US economy expanded by 3.2% q-o-q on an annualised basis in 1Q 10. We look at some of the drivers of growth in this update.

Author : iFAST Research Team

Untitled Document
Chart 1: Job market conditions improving
Chart 2: Durable goods spending rebounding
Chart 3: Consensus raises forecast for growth, but not consumption

Key Points

  • 1Q 10 GDP expanded 3.2% q-o-q annualised
  • Third quarterly expansion following the economic downturn
  • PCE gained a better-than-expected 3.6% q-o-q annualised, suggesting that consumption is recovering
  • Private domestic investment continued to expand, helped by inventory restocking
  • Consensus has raised forecast for growth, but not consumption
  • Nevertheless, we still expect GDP to surprise on the upside this year
  • Rebound in consumption has positive implications for corporate profits
Table 1: GDP Components (Annualised quarter-on-quarter change in %)

4Q 08

1Q 09

2Q 09

3Q 09

4Q 09

1Q 10*

Gross domestic product







Personal consumption expenditures







Gross private domestic investment





















Government consumption expenditures and gross investment







Source: US Bureau of Economic Analysis, * denotes official advanced estimate

According to advanced estimates, the US economy expanded by 3.2% on an annualised quarter-on-quarter basis in 1Q 10, following a 5.6% expansion in 4Q 09. This represents the third consecutive quarterly expansion (see Table 1), a positive indication that the US economy is on the path of recovery after four straight quarters of contraction (from 3Q 08 to 2Q 09). 4Q 09 GDP growth was revised downwards slightly from 5.9% to 5.6% on the back of weaker consumption and government expenditures.

Consumption recovering

While the Bureau of Economic Analysis’ advanced estimate was slightly below consensus expectations of a 3.4% expansion, personal consumption surprised on the upside, posting a 3.6% quarter-on-quarter annualised increase. US consumers appear to be spending again, with broad-based increases in consumption of both goods and services.

Providing a boost to consumer spending, a stabilising domestic housing market coupled with a substantial rebound in equity markets has led to improved consumer sentiment, driving the Conference Board’s Consumer Confidence index to the highest level since September 2008. While unemployment remains high, more timely measures of job market conditions have shown stark improvements: Nonfarm payrolls recently turned positive (see Chart 1), while initial jobless claims have also fallen considerably.

As noted from the breakdown in personal consumption expenditures (PCE), durable goods spending data indicates a strong recovery in household equipment purchases and recreational goods (see Chart 2), indicating that consumers are willing to spend again. Having worked off the effect of the “cash-for-clunkers” scheme in 3Q 09 which led to a surge in motor vehicle sales (and a subsequent decline in 4Q 09; see Chart 2), PCE figures in 1Q 10 now provide a clearer picture of a recovery in US consumption.

Private domestic investment continues to rebound

At the same time, private domestic investment continued another quarter of strong growth, led by inventory restocking which contributed +1.57% of the 1.67% annualised quarter-on-quarter increase. Inventories gained by an annualised US$31.1 billion, a reversal from the decrease of US$19.7 billion seen in the previous quarter, and marks the first quarterly gain in inventories since 1Q 08. As in our previous forecast (see US: 2010 growth at 3.7%), we expect inventories to add about 1.4% to full-year growth in 2010, and 1Q 10’s GDP breakdown shows that the restocking process is only just beginning.

Critics of the apparently rapid recovery in the US economy are quick to point out that inventory restocking is no more than an adjustment in the system, and cannot be seen as real “growth”. We prefer to focus on the positive implications of the restocking process: Restocking of inventory indicates to us that corporations have previously underestimated demand, suggesting that demand will likely pick up strongly over subsequent quarters. As further indication of business optimism, equipment and software investments rose 13.4% on a quarterly annualised basis, following the 19% rise in 4Q 09. We previously highlighted that capital expenditures-to-GDP had fallen to the lowest levels since 1971, and expect corporations to begin to ramp up capital expenditure amid low borrowing costs and improved economic expectations.

Residential investment remains the key laggard, with 1Q 10’s figures still substantially below 2006 peak levels. It is hardly realistic to expect housing activity to return to peak levels anytime soon. Fortunately, following the sharp dip in activity, even incremental improvements in residential fixed investment will be accretive to GDP in coming quarters.

Imports drag on GDP growth

With restocking activity in place, imports gained 8.9% on a quarterly annualised basis, resulting in net exports subtracting 0.61% from overall 1Q 10 GDP growth. The recent weakness of the EUR means that European exports will provide stiff competition for US exporters, but we do not see net exports playing a major role in determining the direction of US economic growth (our growth estimates factor in a negative contribution from net exports in 2010).

Consensus raises its forecast for growth, but not consumption

In our previous quarterly update (US 4Q 09 GDP better-than-expected, recent market correction a temporary pullback), the consensus forecast for 2010 GDP growth was 2.7%. In light of the improving economic conditions, this has now been revised upwards to 3%. Interestingly, this upward revision comes without any increase in estimates for PCE, the largest component of GDP (see Chart 3), and suggests that the consensus is merely factoring in inventory rebuilding as well as stronger private investment. What this means is that the consensus may be underestimating the recovery in PCE, and it will not surprise us if 2010 full-year GDP growth comes in substantially stronger-than-expected.

Despite strong YTD performance, valuations remain undemanding

As of 30 April 2010, the benchmark S&P 500 index has risen 6.4% on a year-to-date basis (in USD terms, +4% in SGD terms), making it the strongest performing regional equity market under our coverage. From the March 2009 lows, the US market has risen 75.4% (in USD terms, +55.2% in SGD terms), a very strong performance in a relatively short period of time. Is it time to sell US equities after such a strong rally?

We think not. Purely looking at prior percentage returns as a gauge of a market’s attractiveness omits consideration of the underlying market earnings. Since the beginning of 2010, consensus estimates of earnings for 2010, 2011 and 2012 have been revised upwards by 5.2%, 2.9% and 4.0% respectively. Based on the market’s close on 30 April, this translates to forward PE multiples of 14.8X, 12.5X and 11.0X for the three respective years, valuations which are relatively undemanding. Given that we expect GDP growth to surprise on the upside this year, we do not rule out the possibility of further upward revisions to corporate earnings, which could drive valuations even lower.

At this juncture, we continue to maintain a 4.0 star “very attractive” rating on the US equity market. The US consumer is clearly on the mend, which has positive implications for corporate profitability in the coming quarters. Investors who wish to participate in the recovery of the US economy should consider allocating a portion of their core equity portfolio to US equity funds.


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