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GDP UP 2.7% IN Q3, CORPORATE PROFITS GROW By Mark Lieberman, Economist for the Five Star Institute Real gross domestic product (GDP) growth for the third quarter was revised up significantly, reaching 2.7 percent annualized, the Bureau of Economic Analysis (BEA) reported. Economists had forecast a 2.8 percent growth rate based on BEA's first estimate of 2.0 percent in October. In the same report, BEA said corporate profits in the third quarter rebounded to $1.752 trillion (annualized) from $1.665 trillion in the second quarter. Profits in the third quarter grew an annualized 22.7 percent after dropping 1.4 percent in the second quarter. Corporate profits on a year-over-year basis increased 18.6 percent, compared to 14.5 percent in the second quarter. The improvement in profits bodes well for the labor market, and indeed, employers added 171,000 jobs in October, according to the Bureau of Labor Statistics. The GDP report revealing 2.7 percent growth was the second of three monthly reports and billed as the "second estimate." The report on profits was the first of two and labeled "preliminary." Final reports on both were issued in late December. The economy grew at a rate of 1.3 percent in the second quarter and 2.0 percent in the first. The make-up of the GDP growth shifted in this latest report away from demand components— sales of goods—to inventory investment. The revisions were largely due to higher estimates for inventories, nonresidential investments, and exports. Consumer spending was revised down, as was investment in business equipment. Estimates for residential investment and government purchases were virtually unchanged. Inflation for the GDP price index remained strong in the third quarter, revised down slightly 22 to 2.7 percent from the initial 2.8 percent reading and up from 1.6 percent in the second quarter. Analysts forecast 2.8 percent. Excluding food and energy, inflation was 1.3 percent in the third quarter, down from the initial estimate of 1.5 percent and from 1.4 percent in the second quarter. The 2.7 percent growth rate exceeded the average of 2.5 percent since 1991, but is below the longer-term average and the 3.0 percent level need to add enough jobs to make a significant dent in the nation's unemployment rate. In dollar terms, GDP grew $89.6 billion in the third quarter, higher than the $67.7 billion advance estimate. According to the revised report, consumer spending contributed $33.4 billion to the overall growth, down from $47.8 billion in the advance report and $35.7 billion in the second quarter. Government spending at all levels added another $21.3 billion—compared with the advance estimate of $22.4 billion—in the third quarter, reversing a subtraction of $4.3 billion in the second quarter. Residential fixed investment accounted for $12.2 billion in the third quarter, according to the revised report, virtually unchanged from the $12.3 billion in the advance report of the third-quarter GDP increase and up from the $7.2 contribution in the second quarter. Overall, residential fixed investment was 2.72 percent of GDP in the third quarter, up from 2.65 percent in the second. The growth in profits was led by financial corporations, with aggregate profits of $71.3 billion in the third quarter compared with a loss of 11.9 billion in the second. RISING PRICES COULD LIFT 3.5M HOMEOWNERS OUT OF NEGATIVE EQUITY While almost one-quarter of homeowners remain underwater, rising home prices over the past year have some economists hopeful negative equity could soon begin to diminish. While "[a]dmittedly, the recovery is still in its infancy," Capital Economics sees the potential for 3.5 million homeowners to move out of negative equity positions the next 12 months. CoreLogic reports prices rose 6.3 percent over the 12 months ending in October, and Capital Economics notes the biggest gains are occurring in the same locations that experienced the greatest price declines and highest instances of foreclosures and negative equity during the housing crisis. For example, about 40 percent of homeowners in Arizona and Florida are underwater. However, home prices have risen 18.7 percent and 6.3 percent, respectively, in these two states the past year. While Capital Economics is sticking to its prediction that house prices will rise about 5 percent in 2013, its economists admit "the upside risks to that forecast are clearly rising." In 2012, rising home prices have helped 1.3 million households emerge out of negative equity positions, according to CoreLogic. In addition to the almost one-fourth of homeowners who still owe more on their mortgage loans than their homes are worth, almost half of mortgage borrowers do not meet the 80 percent loan-to-value (LTV) ratio required for a standard refinancing. If home prices were to rise by 10 percent in 2013, Capital Economics says about 3.5 million borrowers would be lifted out of negative equity and 6 million would become eligible for standard refinancing after seeing their LTVs fall back to or below 80 percent. With home prices still about 27 percent below their 2006 peak, 10 percent under-valued compared to current rental rates, and 20 percent under-valued compared to per capita incomes, Capital Economics sees no need for concern over another bubble as prices continue to rise. KNOW THIS Almost one-third of all sales over the prior year were distressed, Lender Processing Services reported based on data through October.

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