"Kee" Points with Jim Kee, PhD.

The advance estimate for third quarter US GDP growth (annualized) came in at 2.9%, which was at the high end of estimates and more than double the growth rate of the second quarter and over triple that of the first quarter. I mentioned last week that consensus estimates seemed to be converging around the 2.5%-3% range. While consistent with our expectations of a stronger second half, there are several reasons to believe that fourth quarter GDP growth (i.e. next quarter’s GDP) will come in below this (but still above the first two quarters).

The surprise or larger than expected components were mainly inventory investment increases and export growth. The inventory increase, in which businesses produce more (adding to their inventories) than they sell, is expected to reverse itself somewhat in the fourth quarter, as inventory increases often do. And published data on US trade in goods and services don’t really corroborate the export surge, so that could be temporary as well (Asian Times). Personal consumption growth, which most economists zero in on, was a somewhat disappointing 1.47% (versus expectations of 2.6%). I think that is why the market’s response to the GDP release was so lackluster. But inventory growth can also reflect expectations of stronger sales in the future, and the export increase can also reflect the longer-term adjustment of US exporters to the stronger dollar that we have experienced over the past few years. It is for these reasons that I expect fourth quarter GDP growth to stay above that of the first two quarters.  

Many feel that third quarter GDP numbers are “massaged” to look good by incumbent parties prior to elections, and indeed third quarter GDP estimates do tend to be revised downward more in election years than not, and it is a bipartisan phenomenon. But the archives of the Federal Reserve Bank of Philadelphia, which records preliminary GDP estimates, only go back to 1965, so that’s really only 12 data points. And since third quarters in general tend to be revised downward more than the other three quarters, election year or not, there just isn’t really enough data to make a strong statement here (E21-The Manhattan Institute).

Current mega-merger wave: There have been many apparent merger waves in US history, like the horizontal mergers (same industry) at the turn of the 20th century, the diversification or conglomerate mergers (different industries) in the 1960s, and some say the mega-deals announced recently, which builds on last year--the biggest ever in terms of announced worldwide deals ($4.7 trillion-The Atlantic). My initial thought is that increased M&A (mergers and acquisitions) activity is a good thing; it reflects more confidence in the future--more risk taking--than merely building up cash, buying back stock, paying out a dividend, or paying down debt. Of course, even more confidence in the future would be reflected in organic capital spending like new plant and equipment, research and development, stores and leases, but this type of spending remains somewhat muted.

Many of these are industry consolidation moves due to industry over-capacity, a function of both the end of the above-average global growth trend of the 2000s (coinciding with China joining the World Trade Organization and gaining access to world markets) and of the huge amount of cash reserves (and record low borrowing costs) on corporate balance sheets. Others have been more growth-oriented, rather than industry consolidation/cost-reduction strategies. Interestingly, the consulting group McKinsey & Company has found that consolidation mergers, as opposed growth-oriented deals, tend to be more profitable to shareholders. In general, industry consolidation mergers allow firms to cut costs (which creates shareholder wealth) through economies of scale by reducing duplication of resources, or economies of scope, which occur when it is less costly for one firm to perform two activities than for two specialized firms to perform them separately. Growth-oriented mergers and acquisitions, on the other hand, have the potential to create shareholder wealth if they:

Complete a firm’s product line in an industry characterized by ‘one stop shopping’ customers;

  • Allow access to new customers through cross-selling opportunities;
  • Provide a new distribution channel to access to new customers/markets, or to sell into or source more cheaply from foreign markets;
  • Allow the leveraging of a strong brand name or management team;
  • Solve a supply/quality problem or allow more efficient production planning. This is often called “upstream’ vertical integration and often involves ‘economies of continuity of operations’; or
  • Reduce advertising and sales promotion costs or inventory costs by guaranteeing a certain market for the firm’s output (called ‘downstream’ vertical integration
  • That’s my attempt to consolidate about 60 years’ worth of literature and research on the subject of mergers and acquisitions!

Pollyvote: Clinton 53.3%, Trump 46.7%.