"Code Blue" For GDP - Paging Dr. Bernanke
I am not going to bore you with further discussion of the most recent downward revision to the 1st quarter GDP report from 2.4% to 1.8%. While this downward revision certainly "shocked" mainstream economists and analysts - it really should come as no surprise given the ongoing weakness in the data trends of the underlying economic reports as I have discussed in the past. (See here, here and here) The reality is that the economy has been mired in a slow growth recovery ever since the end of the last recession and continues to remain in an induced "coma" due to the massive financial assistance from the Federal Government in the forms of bailouts, financial supports, bond buying programs and suppressed interest rates which limit productive investment and growth.
The incoming economic data most recently suggests that this "comatose state" in the economy is set to continue in the month's ahead with the data reflecting short-lived oscillations between growth and weakness in the economic fabric. As I discussed recently, the Federal Reserve has lowered their economic growth forecast for all of 2013 from 2.6% to 2.5% which is still likely high given the most recent reports. In this regard let's review the patient's vitals to see where we currently stand and what we can expect in the months ahead.
Gross Domestic Incomes Were Up
In the "signs of life" category there was in increase in gross national incomes. As shown in the chart below - while gross domestic incomes did rise in the latest quarter from $13.67 to $13.73 billion the annualized rate of growth in domestic income actually fell from 1.67% to 1.62%. Historically, when domestic income growth has been below 2% on an annualized basis the economy was either close to, or in, a recession.
The good news is that if gross domestic incomes, and gross national product, can continue to accelerate in the months ahead we should stronger economic growth. However, while these two data points show that the economy has a "heart beat" - the current rates of growth are far to weak to declare the "patient" out of danger of slipping back into a recessionary state.
Inventory Buildup Unlikely Wanted
If we look at the net change between Q4 and Q1 final GDP, by major category, we find that the bulk of the increase in Q1 came from what is likely an unwanted buildup in inventories. The chart below shows the breakdown.
While personal consumption did increase modestly in the between Q4 and Q1 there was definitive slowing in fixed, building and productivity investments. This suggests that domestic demand is waning given the currently weak global economic conditions which has led to a buildup in inventories in the short term. Imports also declined suggesting that the domestic consumer may be reigning in their spending which does not bode particularly well for stronger economic growth in the 2nd quarter.
Exports Continuing To Weigh On Corporate Profits
Exports are a much more important component to watch in terms of economic strength these days versus past history. Exports make up as much as 40% of the profits of domestic companies today. Over the last couple of quarters, in particular, as the recession in Europe has continued to grind along, China has begun to slow and Japan is "muddling" along with the U.S., it is not surprising to see exports begin to peak for the current economic cycle. As shown in the chart below this is "not your fathers economy" that was once driven on the back of automobile and residential construction but rather a global economy where exports and durable goods are now primary contributors to economic growth.
While there has been much media attention given to the housing recovery story it is a very small contributor to the overall economy currently. The massive surge in globalization in the last couple of decades has changed the economic landscape to a greater dependency on consumption rather than production.
With the global economic weakness gaining momentum we will want to watch the recent decline in exports as it will weigh not only on economic growth but corporate profitability.
"Code Blue" - Where's Dr. Bernanke?
When looking behind the headline numbers of the economic reports it is clear that there are still substantial pockets of weakness. Over the last 48 months the economy has ebbed and flowed depending on artificial stimulus programs from the Federal Reserve. When these programs were withdrawn economic growth stalled. As shown in the chart below the economy is not only growing at below a 2% annual rate for the last two quarters but the long term downtrend suggests that the current economic expansion that begin more than 4 years ago may have peaked for the current cycle.
Furthermore, as we have noted above, growth rates below 2% have "normally" been associated with an economy that was either in, or about to be in, a recession. In 2011 the economy "dipped" towards recessionary territory during the previous "debt ceiling" debate and withdrawal of Federal support. Currently, the economy is once again below that 2% warning level, currently at 1.6% for the second quarter in a row, and warning of a weak economic environment.
With the Federal Reserve suggesting that they will reduce economic support in the future by "tapering" their bond buying schemes, a debt ceiling debate looming just ahead (Congress is set to put up a fight against further spending and tax increases) combined with global economic weakness - the forecast for an economic revival may be overly optimistic.
The economy is clearly on "life support" and has been surviving on the "forward pull of consumption" created by the ongoing artificial stimulus programs of the Federal Reserve. Like any good doctor, while the FOMC lowered the patients "condition" in their most recent projections; Dr. Bernanke publically announced that he was seeing signs of improvement keeping "hope" alive. The reality is that while the economy may still have a "heartbeat", as witnessed by spurts of activity, it is far to soon to remove the artificial supports that currently keep the patient alive.
While the financial markets currently believe that the Federal Reserve will reduce their support programs sooner, rather than later, the reality is that this will likely not be the case. With the Affordable Care Act set to kick in by the end of this year, an outright brawl between the branches of the government over the budget, spending and taxes, and weakening exports due to a ongoing global recession the economy faces a very tough battle for recovery from here. While the Federal Reserve has a very limited ability to impact real economic growth - the lack of fiscal policy from Washington has put the patient back in danger of slipping back into recession. While Dr. Bernanke may hint at reducing the current forms of "life support" the reality is that this could be much more problematic to actually do.