Today's Headlines: The Dismal U.S. GDP

And Why Nobody Cares About the Country’s Contraction

Today's Headlines:  The Dismal U.S. GDP
July 1, 2014
Final Q1 GDP Numbers Sink Further

Final Q1 GDP numbers were released last week by the Bureau of Economic Analysis that revealed a depth of contraction that surprised many analysts. Since first reported earlier this year, Q1 GDP has progressively plummeted from an initial 0.2% growth rate to a 1.0% decrease and finally a 2.9% contraction.

The GDP is issued three times – one immediately after the close of each quarter, again one month later, and a final time a month after that. These are known, in order, as the advance, preliminary, and final reports. There will be another number with historical revisions next month (back to Q1 1999), but this "final" GDP is the primary number for comparison to past quarters.

Why is the GDP revised so often? Think like an accountant. Getting a snapshot value of the funds in any business is no easy matter, because of the lag time associated with transactions and the summarizing of information. Now extrapolate that to an entire nation.

The advance number is based primarily on estimates; the final number on data, with the preliminary fitting somewhere between. Usually the preliminary and final revisions are close to each other, but a drop like this is not unheard of.

Do Not Panic; All Is Well

Why do so many economists gloss over these results? Can everything be dismissed with a wave of the hand because of the bad weather the country suffered through this winter?

It may sound fishy but it does make some sense. Inventories, which are always year-end dependent, accounted for 1.7% of the 2.9% drop, according to the BEA (Bureau of Economic Analysis) report. Real gross domestic purchases fell by 1.4% in Q1, state and local government spending decreased 1.7%, and the trade differential increased substantially (imports increased 1.8% and exports decreased by 8.9%). All of these can at least plausibly be blamed on the weather or typical end-of year adjustments that are slower than usual to recover.

The one outlier was a decrease in healthcare spending, which seems at odds with the new healthcare law. Are people not taking advantage of their newly insured status? Could Obamacare actually be reducing costs this quickly? It is too early to conclude anything – Neil Irwin of the New York Times suggests that healthcare may fundamentally skew the GDP assessment by introducing a short-term unpredictability while the effects of Obamacare sort themselves out.

Looking Forward or Backward?

It is important to consider several factors when interpreting economic information – is the information looking forward based on estimates, is it a snapshot in time, or is it looking backward based on data? The GDP numbers are backward looking, and snapshots and future estimates seem to paint a rosier picture.

Last week's housing reports were particularly bright. Existing home sales were up 4.9% in May for the first back-to-back gain in some time, and new home sales rocketed up 18.6% in May, surpassing all expectations. MoneyTips is happy to help you get free refinance quotes from top lenders.

Jobless claims have been steadily decreasing throughout 2014, and jobs are slowly gaining but gaining nevertheless. Over one-million jobs have been created in the last five months, which is not consistent with a contracting economy.

The Manufacturing sector is also looking up – last week's PMI Manufacturing index increased slightly, as have most indicators that businesses are starting to crank up production. Personal spending stayed constant in May, with inflation rising slowly.

The Takeaway

If the May reports were a more mixed bag, there would be more cause for concern, but the majority of this month's reports give information consistent with slow or moderate growth – out of sync with the Q1 GDP analysis. The economists are probably correct. However, the degree of recovery may be a little slower than the rosier growth estimates.

The preliminary estimate of Q2 GDP will be out in July. If this also shows anemic growth of GDP and business investment, it would indicate that jobs are being added disproportionately to growth, which is not sustainable.

Business investment is the biggest wildcard, as businesses are sitting on huge reserves of cash (perhaps those pumped into the system by the Fed?). Why aren't they investing? Our guess is continued uncertainty about demand, the effect of healthcare, and concerns about a long overdue stock correction.

We are betting uncertainty remains, especially with an upcoming election, Middle East instability, and healthcare battles likely to resume as the effect is understood and absorbed. It seems more likely that businesses will be reluctant to invest their cash and weaker growth will prevail throughout this year. The Fed appears to agree, as it recently cut its 2014 GDP forecast from 2.8 - 3% down to the more conservative 2.1 - 2.3%.

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