The latest report card for U.S. economic growth came in today and lots of folks are patting themselves on the back. Stocks rose on the news, with the S&P 500 and Nasdaq hitting new highs.

Let’s set the “wayback machine” to 1928. That year, President Herbert Hoover was gloating about American economic growth and the roaring bull stock market. He stated that no country in the world was closer to abolishing poverty than the United States. A year later the stock market crashed, ushering in the Great Depression.

I’m not predicting that a similar calamity will happen anytime soon. My point is, when politicians brag about economic data, take the self-serving theatrics with a grain of salt. Keep your eye on the long-term trends that lie beneath the headline numbers.

The U.S. Commerce Department reported Wednesday that U.S. gross domestic product (GDP) growth in the second quarter came in slightly stronger than initially thought, expanding at a revised annual rate of 4.2%, up from the initial estimate of 4.1%, for its strongest performance in about four years.

The economy appears to be on course to meet President Trump’s goal of 3% annual growth. Trump tweeted that second-quarter economic growth was “historic.” His assertion is completely untrue, but let’s put that aside.

More importantly, the 3% goal simply isn’t sustainable. We’re already seeing warning signs that the economy will significantly slow down in the latter half of 2018.

Second-quarter growth benefited from one-off events. It’s akin to injecting steroids. The temporary stimulus eventually fades and causes lasting harm.

But for today anyway, reports of faster growth boosted the stock market, with technology stocks leading the way. Small-caps continued their upward trajectory, as faster expansion fueled investor bullishness toward little companies. The Russell 2000 Index today rose 0.37%. The small-cap focused Russell 2000 has gained 11.5% year to date, compared to 7.0% for the S&P 500.

In today’s second estimate of GDP growth for the April-June quarter, the government said GDP growth far exceeded the previous five quarters (see chart, compiled with Commerce Department data):

But context is called for. Strong second-quarter growth was largely driven by one-time factors such as the $1.5 trillion tax cut package, which stimulated consumer and business spending, and front-loaded shipments of soybean exports to China to beat tariffs.

The corporate tax cuts have created a massive federal revenue shortfall, while at the same time federal spending rose at a 3.5% rate in the second quarter

The result is a ballooning budget deficit that will come back to haunt financial markets in the form of hotter inflation and higher interest rates. The government also reported today that the rate of inflation was moved up to a 1.9% annual pace from 1.8%.

Consumer spending remained strong in the second quarter, though a bit less so than previously calculated. Outlays rose 3.8% instead of 4%.

NAFTA’s three-ring circus…

Most economists expect growth to start sputtering in the third quarter. And as the year wears on, the trade war will take its toll.

Canada and the U.S. started bilateral trade talks today, as the two trading partners try to preserve the North American Free Trade Agreement (NAFTA) that encompasses the U.S., Canada and Mexico.

After several weeks of tit-for-tat tariffs and personal invective, leaders of the U.S. and the Great White North appear ready to compromise. Recent history shows, though, that discussions could suddenly collapse at any time. Negotiations over the three-nation trade pact have become a three-ring circus.

The U.S. and Mexico announced a bilateral deal Monday, paving the way for Canada to rejoin negotiations to revamp NAFTA, which accounts for more than $1 trillion in annual trade between the three nations.

Canadian officials stated yesterday that Mexico’s concessions on auto rules of origin and labor rights were a big breakthrough. Trump threatened to go ahead with a bilateral deal with Mexico if Canada wouldn’t come to heel. Sticking points include intellectual property rights and extensions of copyright protections.

However, to break up the current three-country trade agreement and make it bilateral, Trump would need approval from Congress, which he’s unlikely to get.

In negative economic news today, the National Association of Realtors (NAR) reported that its Pending Home Sales Index, based on contracts signed in July, fell 0.7% to 106.2 in July. Economists had expected an increase of 0.3%.

NAR cited supply shortages as the main culprit, as the lack of homes on the market drives up prices to levels that many buyers find unaffordable. The cooling of the crucial housing market poses a concern for investors, because it’s seen as a bellwether of overall economic growth.

This bull market still has legs, but you should reduce risk. Transition your portfolio toward value stocks, especially small caps. Increase your cash levels. Boost your exposure to inflation hedges. And regard with profound skepticism all government pronouncements about the economy.

Wednesday Market Wrap

• DJIA: 26,124.57 +60.55 (0.23%)
  
• S&P 500: 2,914.04 +16.52 (0.57%)
  
• Nasdaq: 8,109.69 +79.65 (0.99%)
  

Wednesday’s Big Gainers

• Affimed (NSDQ: AFMD) +10.81%

Biotech announces collaboration with Big Pharma.

• Unisys (NYSE: UIS) +9.25%

IT firm signs huge government contract.

• Workiva (NYSE: WK) +6.58%

Enterprise cloud provider enjoys booming demand.

Wednesday’s Big Decliners

• Assertio Therapeutics (NSDQ: ASRT) -11.00%

Biotech settles patent infringement lawsuit on mixed terms.

• American Eagle Outfitters (NYSE: AEO) -6.52%

Apparel retailer issues weak profit outlook.

• Kewaunee Scientific (NSDQ: KEQU) -6.27%

Lab furniture maker’s earnings disappoint.

Letters to the Editor

“How has NAFTA affected jobs in the U.S.?” — Larry G.

About 14 million U.S. jobs rely on trade with Canada and Mexico combined, and the roughly 200,000 export-related jobs created annually by NAFTA pay an average wage of 15% to 20% more than the lower-skilled jobs that were lost.

Questions or opinions about the trade war? Drop me a line: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.