GDP - Digging Into The "Unexpected" Decline
This morning the media was shocked as the 1st estimate of Q4 GDP dropped to a negative .01% growth rate. This, of course, was "unexpected" by the consensus who had predicted an increase of 1.0%. The good news is that this number will be revised up in the next couple of months due to the impact of Hurricane Sandy, which temporarily boosted production, and the "fiscal cliff" fiasco which pushed businesses to ramp up durable goods orders in December due to expectations that the investment tax credit would be allowed to expire.
There is also the impact of what is currently the warmest winter weather in 55 years, and I realize that we were writing this last year at this time as well, which is skewing the economic data higher due to the impact of the seasonal adjustments. These factors all led to increases in consumer spending, housing and capital spending. Given the effects of these artificial supports on economic production it is very likely that GDP for the 4th quarter of 2012 will push back toward 1% by the time the final data is in.
On the negative side were sharp drops in government spending at all levels but primarily in defense. Businesses, which are much more worried about the economy due to weak end demand, drained inventories and the continuing recession in the Eurozone hit exports. The chart below shows these net changes by category between Q3 and the 1st estimate of Q4 GDP.
That is the good news. The not so good news is that the trend of the data still confirms that economic growth is "muddling" along and remains very subject to exogenous shocks. The line between growth and contraction is very narrow and is primarily being supported by the continued interventions by the Federal Reserve to suppress interest rates. The chart below shows the annual percentage change in economic growth.
This is hardly a picture of economic health and at just 1.54% we are running at dangerously low levels when normally the economy should be growing at double that rate in the fourth year of an economic recovery.
Of course, none of this takes into account the impact of the fiscal squeeze that is coming as an extra 2% is extracting from employee payrolls in 2013. While inventory restocking, following the sharp contraction in Q4, will lend support to the economy in Q1 of 2013 - the major driver of the economy, as shown in the chart below, is the consumer.
Personal Consumption Expenditures (PCE) makes up more than 70% of the economy and drives virtually everything else due to the "demand" impact on businesses. Everything else from inventories, housing, exports, imports and government spending all make up the balance. While PCE did rise in the latest GDP report what is far more concerning is the trend of consumption as shown below.
This weakness in consumption, as shown in yesterday's report, is likely to deteriorate further in the coming quarter as the impact of lower incomes due to higher taxes weigh in. This issue is also a likely culprit in the recent plunge in consumer confidence as well as the average American family just saw their monthly incomes clipped by an average of $110. For the majority of Americans, which are already living paycheck-to-paycheck, the deduction to family incomes is significant.
Does the negative print in Q4 GDP mean that a recession is imminent? No. As I stated above; GDP will be revised higher in the next couple of months which will put recession fears to rest temporarily. However, it is also not an absolute certainty that the many individuals in the "no recession" camp will be right either given the fact that the data revisions to much of the 2012 economic data, which will come later this year, will likely shown an economy that is much weaker than currently estimated.
As stated above there is very little "wiggle room" for the economy at this point to absorb much of a shock. With real final sales plugging along at 1.9% and the output gap above 6% the slack in the economy is huge. As a reminder these numbers are generally levels more associated with recessions and not four years into a recovery.
"...I wonder how many people realize the nominal GDP growth- which takes into account BOTH volume spending and prices - downshifted dramatically from a +5.9% annual rate in Q3 to just +.05% in Q4. We haven't seen such a minuscule reading since the depths of economic and financial despair in 2009 Q1 and let it be known that never before have we seen such a depressed print in NOMINAL GDP growth without the broad economy actually being in a recession. In fact, nominal GDP growth - both average and median - is +2.3% sequentially during recessions or more than four times stronger than what we just saw for Q4. It was also the weakest pace ever for a non-recession economy on record (the closest we got to beating this number was 0.6% in 1959 Q3...but the recession was merely delayed at that point, not derailed, as by 1960, the downturn was getting into full swing.)"
Of course, the fact the economy can run at such subpar growth rates without technically being in a recession is a function of the "new normal" of an economy supported by trillions of dollars of stimulus. This also goes a long way to support the idea that recent claims that the economy is on the verge of an acceleration in growth are likely based more on "hope" than "reality." The economy will likely continue to "muddle along" only as long as the Federal Reserve continues to support it by artificially suppressing interest rates and flooding the system with liquidity. Without such support there is little argument that the economy would have already been in another recession.
A recession will inevitably come it is simply part of the economic and business cycle. The Fed may be able to slow, or distort, economic cycles but they cannot repeal them entirely. Whether a recession comes this year, or next, is largely irrelevent the issue will be the damage caused to investors by the impending reversion as reality collides with fantasy.
In the meantime, the markets continue to surge due to the impact of liquidity in the system. With CNBC now counting down the points remaining to reach 2007 highs investor exuberance is ratcheting higher. How it all ends no one really knows for sure as the central bankers of the world have bet it all on a globally coordinated liquidity plunge. Of course, as my mother used to say: "It's all fun and games until someone gets their eye put out."