Q1 GDP - Weaker Than Expected
On March 1st we penned "For all of these reasons it is very likely that when we begin seeing reports for the Q1 GDP for this year they will be much weaker than currently anticipated." At that time, due to the weakness we had estimated GDP to come in around 1.25% for the Q1. However, recent strength in spending and the net export numbers caused us to raise our estimate to 2%. Today, the BEA released their first estimate, of three, for Q1 GDP at 2.2% which was slightly above our estimate but lower than the consensus estimate of 2.5% and materially lower than the high end estimates of 3.5%.
As we discussed in our original post on 4th quarter GDP "There was an incredibly large surge in Q4 in the business investment category. Railroads and trucking companies have recently reported upticks in tonnage hauled. Likely, we will begin to see a reversal in the coming months as the surge in activity was primarily attributable to a rush to purchase capital goods ahead of the expiration of the100% bonus depreciation allowance. That surge, which has now pulled forward future capital expenditures into 2011, will likely leave a void in coming quarters. Companies have been boosting 2012 views based on the past couple of months of activity - this could be a very dangerous trap for investors."
In the first chart you can see the decline Gross Private Domestic Investment as the year-end rush fades. Furthermore, as my friend Cullen Roche who tracks rail data shows, the surge in Q4 rail traffic has peaked and began to decline. While still currently positive — the trend is becoming more negative. This supports the fading of the year-end rush and has shown up in the recent manufacturing reports as well.
We have stated many times that the pickup in the Q3 and Q4 in the economy was not from a resurgence of "real" economic growth but from the disruption in manufacturing that occurred post the Japanese earthquake/tsunami/nuclear disaster tri-fecta. You can see that the sharp upturn in Goods and Durable Goods, which has been mostly inventory rebuilding, has now begun to level out.
Furthermore, the recent 2.1% decline in business spending is very concerning. The corporate sector is a driver of future productivity growth, increases in the standard of living due to increasing wages and job gains. The decline in the spending is the first that we have seen since the end of 2009. If the recent 4.5% drop in durable goods is telling us anything - it is likely pointing to weaker numbers ahead.
The consumer carried the load in Q1 through an increase in personal consumption expenditures, however, it was mostly driven by a decline in the savings rate and an increase in credit. Considering the weakness in real income growth the current rate of expansion in PCE is unsustainable. Therefore, it is likely the downward revisions to Q1 GDP will be centered on the PCE component in the months ahead.
However, the current 2.9% advance in Personal Consumption Expenditures (PCE) was an increase over Q4 spending which rose only 1.52%. The bigger issue concern is the sustainability of it going forward?
Here are some statistics for the first two months of 2012:
- The year over year change of "real" personal incomes has declined by 61%.
- Personal saving rates have declined by 20%.
- Consumer Credit Outstanding rose by 1.1% or $27.3 Billion. However, that is sharply lower than the $42 Billion increase in Q4 which may be indicating that consumers are reaching their limits.
With "real" personal incomes and savings rates on the decline it is no surprise to see increases in consumer credit. The struggle to maintain the standard of living affects the majority of Americans. To understand this better just watch the service sector which comprises 66% of PCE. It has remained virtually flat for the last six months.
We had stated previously that "in real term's consumer spending was flat which bode's poorly for upcoming reports for 1st quarter GDP." We saw this play out in today's report. As we showed in our report on consumer credit: "The rise [in consumer credit] is NOT about increasing consumption by buying more 'stuff' it is about just about being able to purchase the same amount of 'stuff' to maintain the current standard of living." The impact of higher oil and gasoline prices have not been fully accounted for in the current GDP report. The increased drag on incomes will likely be more prevalent when we start talking about Q2 GDP.
The supportive weather patterns, which represented a three-standard deviation event during Q1, combined with "Operation Twist" or QE 3, the European LTRO's, also gave an artificial boost to GDP in Q1. As liquidity programs come to an end and weather patterns return to norms the positive boosts will continue to fade into the summer. If we backed these supports out it's likely that Q1 GDP growth was closer to our original estimate of 1.25%. The automobile sector, due to massive dealer inventory channel stuffing, played an huge role in Q1. That effect will also fade in the coming quarter ahead.
Lastly, if we take a look at "real" final sales the picture really becomes much clearer. Does this chart of "real" final sales (real GDP excluding inventories) look like an economy that is growing? The reality is that seeing numbers at this level given all the varying levels of monetary and fiscal support is disturbing at best. The economy is far more fragile than most media and economic analysts realize. This leaves the economy extremely vulnerable to contractionary shocks even at this very late stage of the business cycle.
Given the impact from higher oil and gas prices on the economy, which is a real and pervasive tax on the consumer as discussed recently, it is highly likely that we will see downward revisions to Q1 GDP in the next two months. The markets are currently rallying with the assumption that a weaker than expected GDP will lead to more QE soon, however, the dicatomy here is that if the economy was "truly" recovering as we are told by the media why are we still talking about further QE programs? While the next QE "fix" may be supportive for the market — mainstream America continues to struggle to make ends meet.