GDP - Revised Down
When we last reported on 3rd Quarter GDP we said: "This is the first estimate of the 3rd quarter economy (July-September) and generally is geared to the average estimate of the analysts which consequently was also 2.5% since there it little actual data to work off of. In the next two reports that come out we will see more concrete detail about the actual strength of the economy." We also stated at that time that: "While the report was better than last quarter I suspect that we will see this number revised down in the coming months as we head into the end of the year"
This is what we saw today as the first revision to GDP was released with a downward revision to 2.0 percent annual rate from the previous estimate of 2.5%.
This is a fairly substantial 20% reduction in the initial estimate with a drop in inventories being particularly troublesome. Why? Two reasons. First, roughly 2/3rds of the growth in GDP since the bottom of the recession in 2009 has come from inventory rebuilding. The reversal of inventory growth from a $5.4 Billion increase in the original estimate to an $8.5 Billion drawdown lopped off roughly 1.55% from GDP growth. Secondly, and more importantly, the change in private inventories is a sentiment reading on corporate outlooks. Companies tend to manufacture and produce inventory when demand is strong. If they sense economic or demand weakness they begin to bleed down inventories and backlogs. This is precisely what we have seen in many of the manufacturing survey's in recent months.
This concern by business also showed up in a sharp downward revision to private investment by 1.3%. There are a couple of key points here to remember as well. First, companies are currently receiving a 100% tax credit for business equipment purchases this year that will expire in November if not extended by the current Administration. Therefore, this has drug forward future consumption that will hit the economy in 2012 and beyond. Secondly, there was a good bit of ramp up due to the Japanese earthquake that occurred in the 1st quarter as business came back online. That effect was temporary and most likely washed through the system - more on that point in a minute.
One of the key highlights by the media today was that consumer spending was strong in the third quarter even though it was revised down from 2.4 percent to 2.3%. The issue with this, as we pointed out in our detailed analysis of 3Q GDP, was that consumer spending in the summer was driven by utilities and medial bills. The consumer was helped out even more with a drop in oil prices below $80 a barrel which temporarily alleviated some of the pricing pressure. With the recent jump in oil prices in the month of November to over $100 per barrel the effective headwind of the additional "tax" on consumers could very well dampen retail spending in the 4th quarter.
I find it particularly interesting that Wal-Mart is starting "Black Friday" shopping at 10pm on Thursday evening and going non-stop. Wal-Mart is not the only store doing this either. With retailers already sensing a weak shopping season ahead they will report "Black Friday" shopping results that would should comprise a normal shopping day (9am-9pm) even though it the shopping day has been effectively doubled. Talk about skewing results.
Speaking of consumer spending net imports were revised down by .34% as demand for foreign goods weakened but the good news is that exports strengthened slightly by 0.7%. I have provided the full table of changes to the 3rd Quarter GDP.
Despite the downward revision, last quarter's growth is still a step-up from the April-June periods meager 1.3% pace. Part of the pick-up in output during the last quarter reflects a reversal of factors that held back growth earlier in the year such as high oil prices in the 1st quarter and supply disruptions from Japans big earthquake and tsunami in March had curbed auto production. While there is a lot of excitement over the potential prospects of stronger GDP growth in the 4th quarter of 2011, estimates are already being penned to anywhere from 3-4%, it is important to factor in the following:
- The effect from Japanese earthquake is now accounted for in the economic equation. The vacuum caused by the earthquake on supply disruptions created an artificial production boom Q3. This will be declining effect in Q4.
- While consumer spending was strong in Q3 it came at the expensive of a massive draw down in the personal savings rate.
- Oil prices were as low as $78 a barrel in Q3 and are now teetering around the $100 mark. With food and energy consuming 23% of wages and salaries in Q3; Q4 will likely be substantially worse.
- PCE will likely be lower in the Q4 as a the big push in utility costs this summer due to the heat wave will no longer be a catalyst.
With this in mind it is important to remember that our call for a recession in 2012 is still on the table. The overall trend of the data is still clearly negative even though it can be a bumpy ride along the way. Furthermore, with 20% of exports and corporate profits relying on the Eurozone the pending recession there will have a negative drag on the economy here.
Lastly, as shown in the chart above, whenever the quarterly change in the economy at an annual rate has fallen below 2% historically on a year over year basis the economy was either in or about to be in a recession - 100% of the time. With today's downward revision of the data from 2.5% to 2.0% growth the year over year change in GDP declined from 1.6% to 1.5%.
While it is always possible that the economy may escape a recession this time around, possibly due to some form of further government intervention, the reality is that there are more than enough downward pressure on the economy currently. With the consumer already drawing down on savings to make ends meet, rising oil prices detracting further from disposable income and a possible tax hike in the cards if the Administration fails to extend the "Bush Era" tax cuts and the payroll tax reduction, the odds of success at this point don't look great.