GDP is the broadest measure of economic activity, and the first estimate of fourth quarter GDP will not be out until the end of January. By far the largest component of GDP is personal consumption expenditures. It is fairly certain that fourth quarter durables consumption growth will fall – it was artificially boosted during quarter 3 by the Cash-for-Clunkers program. Non-durables and services consumption will likely be weak, but slightly positive, in part due to an expected weak holiday shopping season.

While quarter-on-quarter GDP growth was positive, year-on-year growth was negative, see the chart below. The year-on-year growth data is more stable than the quarter-on-quarter growth data as can be seen by comparing the second chart which shows the latter growth data. In addition, the year-on-year growth data is conceptually linked more closely to annual percent changes than the quarter-on-quarter growth data. The year-on-year growth data show the economy has, in fact, not recovered at all.

Residential real estate investment is a wild card, but not a particularly big one. It surged in quarter 3 due to the Federal Homebuyer’s Tax Credit. Congress is likely to extend this tax credit prior to the December 1 expiration date. The billion dollar question is: how many families remain who will take advantage of that credit? If there are few, then fourth quarter residential real estate investment will fall relative to the third quarter, weakening fourth quarter GDP.

While Cash-for-Clunkers has expired, the Federal Homebuyer’s Tax Credit is likely to be expanded and extended. A bill is moving through the Senate. Once the bill gets to the House, prospects for passage are high. In addition to extending the $8,000 credit to first-time homebuyers, a new $6,500 credit for returning homebuyers will be available for applicants who have lived in their home for at least five years.

Going forward, the extended and expanded Federal Homebuyer’s Tax Credit could provide additional stimulus to the economy through residential fixed investment, and to a lesser extent, consumer durables. We wonder how much of the related home purchases are adding debt to the household sector. Part of the reason the housing market collapsed was excessive leverage. If the debt levels are still too high, and they may be, this tax credit may be creating more future pain in housing.

We expect motor vehicle sales to be noticeably weaker in fourth quarter, because third quarter sales included purchases that were moved forward from fourth quarter. We expect high unemployment rates, high mortgage defaults, and high foreclosure rates will persist through the fourth quarter and beyond. These will imply at least some weakness in all consumption categories.