4.1% GDP growth isn’t enough to make stock market happy

U.S. GDP (in real terms) grew at a seasonally adjusted annual rate of 4.1% in the second quarter. The economy hasn’t seen 4% growth in the memory of most Wall Street analysts (who do, I admit, have short memories), but it still wasn’t enough. Economists had been projecting 4.1% growth from the quarter so this very solid performance only met expectations. Which means it was a disappointment to anyone hoping for higher growth. Projections on Wall Street before this morning’s report had ranged as high as 4.7% growth. The Trump White House also raised expectations in recent weeks by talking up the prospects for second quarter GDP growth.

This disappointment is one reason that stocks closed lower today. The Standard & Poor’s 500 stock index finished down 0.66% and the Dow Jones Industrial Average was lower by 0.30%. The big losers, though, were the small cap Russell 2000 index (down 1.89%) and the NASDAQ Composite as another tech star disappointed investors on earnings. Twitter (TWTRWealth Strength IndexAAPL is Extremely Up and trending Up) finished the day down 20.54%.

But there was more than disappointment about the GDP growth rate at work to produce today’s down day.

The U.S. stock market is still feeling the effects of Facebook’s big miss on guidance and its almost 20% drop on that news. The slightly larger than 20% plunge in Twitter today certainly kept nerves on edge heading into the weekend. And given the extremely unpredictable news flow lately–Presidential tweets threatening Iran, reports of slowing economic growth from China, Republican plans for another big tax cut–who would want to be any more exposed to the financial markets than absolutely necessary over a weekend?

Also, the market is confused about exactly how much credence to give the 4.1% growth statistic. Some of that growth–as much as 1.5 percentage points according to Morgan Stanley–is a result of companies building inventories ahead of potential tariff increases.

And then there’s the problem that strong economic growth is a two-edged sword at the moment. If you take the 4.1% growth rate at face value, it pretty much guarantees that the Federal Reserve will raise interest rates two more times in 2018 (at the September and December meetings.)

Even if you do some averaging and smoothing the 4.1% growth for this quarter works out to a 2.9% average growth rate for the past four quarters. If that represents the actual growth rate of the economy better than this quarter’s 4.1% growth rate, it is still above the median estimate of Federal Reserve officials of the economy’s potential non-inflationary growth rate of 1.8% and slightly above the Fed’s 2018 growth forecast of 2.8%. That argues that the economy is growing near Fed expectations and that the Fed will stay on course to raise interest rates twice more in 2018.

In other words, growth wasn’t strong enough to produce a real surprise and it was strong enough to cement the odds that the Fed will raise interest rates two more times in 2018.