The 3rd revision to Q1:14 GDP came in at -2.9% making it the worst quarter since Q1:09. The question is should the market pay attention to the rear view mirror or is this an indication of a weaker economy? We think not.
There were multiple factors that conspired to pressure Q1:14 GDP: Two thirds of the revision is in consumption, cut to +1.0% from +3.1%. Healthcare services was revised from adding +1.0% to a drag on growth as a component, cut to -1.4% from +9.1%.
But when we look at possibly leading indicators both manufacturing and service PMI, the underlying economy appears healthier than the GDP estimates.Combined, the two PMI surveys indicate that business activity is growing at the strongest rate seen since prior to the financial crisis.
The Service sector PMI for June cam in at 61.2, up from 58.1 in May.The latest reading indicated the strongest pace of U.S. private sector output growth since October 2009. Service sector output growth has now accelerated in three of the past four months, with a strong rise during June supported by marked improvements in new business inflows.
Indeed, the manufacturing PMI hit its highest for just over four years in June and best quarter for factories for four years. Manufacturing output growth picked up for the third month running to its strongest since April 2010.
Second quarter GDP data are therefore likely to show a stronger recovery. Importantly, this is not just a rebound from the weather-related disruptions, although the degree to which healthcare rebounds is a wildcard. Nevertheless, data is pointing to companies reporting strong demand for goods and services.
Where does that leave us in regard to our investment strategy? While the PMI data points to an underlying economy that may not be as weak as GDP suggests, we remain cautious in an elevated market supported by central banks. Indeed, the consumer is not in a healthy condition in real wage terms, the drag from energy, car loans and student loans. While investor have been served well by the buy the dip strategy, especially in 2014, we remain conservatively positioned in equities focused on select technology, Energy (MLP’s, multinationals), healthcare and materials. Fixed Income we have stayed on the curve looking at ABS, CMBS and Event Driven as a bond substitute and a high cash position.