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Rick Davis Goes Inside the GDP Report

Posted by Larry Doyle on July 30, 2010 11:18 AM |

The equity markets are flat so the 2nd quarter GDP report must have been properly priced into current valuations. Perhaps, but I would neither go that far nor would I be so brazen as to say that the markets are wrong in how they trade. Markets are never wrong. The market is the market. All this said, let’s navigate with Rick Davis inside the 2nd quarter report and the prior revisions.

July 30, 2010 – Inside the New GDP Numbers:

On July 30th the Bureau of Economic Analysis (‘BEA’) released its “advance” estimate of the annualized growth rate of the U.S. Gross Domestic Product (‘GDP’) during the 2nd quarter of 2010. Per their report, the GDP grew during the quarter at an annualized rate of 2.4%, down from 3.7% in the 1st quarter of 2010. Several points from the report merit comment:

► Readers familiar with prior GDP reports will be more surprised by the reported 1st quarter growth as by the new 2nd quarter number (which had been leaked by Mr. Bernanke last week), since only last month the Q1 of 2010 was supposedly growing at a 2.7% rate. Why did the Q1 number suddenly get altered upward by 1%? The BEA quietly revised the 1st quarter inventory adjustment up to a level that represents a 2.64% component within the revised 3.7% figure, with 1st quarter “real final sales of domestic product” now reported to be growing at a modestly improved 1.06% annualized clip, compared to the 0.9% number reported last month. In short, factories were piling on inventory at a substantially higher rate than previously thought, while the “real final sales” remained anemic.

► The 2.4% figure will garner all of the headlines, but the more important “real final sales of domestic product” continues to be weak, growing at a reported 1.3% annualized rate. The real cause for concern is that the reported inventory adjustments dropped from a 2.64% component in the revised 1st quarter to a 1.05% component during the 2nd quarter. If factories have begun to realize that end user demand remains anemic, the inventory adjustments could well go negative soon, pulling the reported total GDP down with it.

(Click on chart for fuller resolution)
► The BEA revised much more than the first quarter of 2010. They revised down 2009, 2008 and 2007 as well. Apparently the “Great Recession” has been worse than our government has previously reported. And the recovery’s brightest moment, Q4 2009, has been revised down from 5.6% to 5.0%. Similarly Q3 2009 dropped from 2.2% to 1.6%. And so on. The bottom of the recession was shifted back one quarter, with Q4 2008 now reported to have contracted at a -6.8% rate, revised down from the previously reported -5.4% rate. Most quarters of 2007, 2008 and 2009 have been revised down substantially, shifting the recession shown in the chart above back in time.

► The new GDP report shows that the current gap between the consumer demand that we measure and the BEA’s reported number continues to grow as factories build their inventories in anticipation of a strong recovery. If factories curb their enthusiasm during the third quarter, the BEA’s “advance” estimate for Q3 2010 might be brutal, just 4 days before the U.S. mid-term election.

► We understand that economists want to ultimately get the numbers right, even if it is three years after the fact. We applaud the BEA for their efforts. But we also understand people who are concerned about quiet governmental revisions to history.

Back to the real world: our Daily Growth Index has dropped to new recent lows, and it is now contracting at a -3.4% rate.

(Click on chart for fuller resolution)
This contraction rate puts the trailing ‘quarter’ nearly into the 5th percentile among all quarters since 1947, meaning that only about 1 in 20 quarters officially recorded by the BEA since then has been worse. Our “Contraction Watch” places this movement into the perspective of the 2006 and 2008 contractions:

(Click on chart for fuller resolution)
The 2010 contraction is now clearly worse than the “Great Recession” was at the same point in their respective time lines. And we don’t see a bottom forming yet.


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  • Steve

    Interesting insights on the GDP report from a previous guest on your radio show, Daryl Montgomery. He posted these comments at Seeking Alpha,

    The Bureau of Economic Analysis reported today that GDP increased by 2.4% in the second quarter. First quarter GDP was revised up to 3.7%. The annual revisions for previous years indicated that the U.S economy contracted at an average annual rate of 0.2% between 2006 and 2009.

    While 2.4% is in and of itself a fairly decent increase in GDP, the components that made up the increase are the key to interpreting how good it really is. To do this, it’s necessary to know whether or not they are sustainable and even whether or not they are believable. Increases in some components are a negative because they ultimately lead to lower growth in the future. Inventories are the best example of this. Others, such as increased government spending are at best neutral because they don’t indicate an improvement in the private economy. If spending isn’t going to be increased further in the future, then this also indicates lower GDP going forward. Finally, some numbers simple don’t match up with other government reports, observations of reality, or economic definitions. If they don’t, they are obviously inaccurate.

    So how do the GDP numbers stack up in the latest report? Based on the official news release from the BEA, which can be found here, it can be seen that:

    1. Inventory increases added 1.05% to second quarter GDP. Based on the annual revision, they added 2.64% to first quarter GDP or 71% of the total increase. Inventories were also responsible for approximately two-thirds of the GDP increase in the fourth quarter of 2009. The entire economic ‘recovery’ has essentially been an inventory adjustment. This does not bode well for the future.

    2. Government spending was up across the board in Q2. Federal spending increased by 9.2% in the second quarter versus 1.8% in the first quarter. State and local spending was up 1.3% this quarter versus a decline of 3.8% last quarter. The second quarter was when stimulus spending was at its maximum. So expect less of a contribution from government spending to future GDP and lower numbers as a result.

    3. The most obvious fantasy figure in the report was the new home construction figure. This supposedly increased by a whopping 27.9%, even though the Commerce Department’s New Residential Structures report (more commonly known as new home sales) indicated a 6% decline quarter to quarter and an 8% decline year over year. Nor is there any evidence of a massive increase in new home inventories or any real world evidence indicating a huge building boom. This number is impossible.

    4. Somewhat suspicious is the increase in investment on business structures (commercial real estate). This was up for the first time since Q3 2008. The big increase in banks going under that is currently taking place is being caused by commercial loans going bad, yet commercial construction is now on an upswing? Perhaps work on the BP oil spill juiced up this number. Interestingly, the UK also reported a huge increase in construction spending last quarter as well, although there is little evidence of much construction going on there. BP is headquartered in the UK, but it spent its money to handle the oil spill in the U.S.

    5. The most ridiculous claim of all was the revised figures for 2008 GDP. Based on original reports, GDP increased by almost 3% in 2008, a very good rate, even though it is universally acknowledge that the U.S. was experiencing the worst economic downturn since the 1930s Great Depression. GDP is supposed to decrease during a recession, not go up. In the revision in July 2009, GDP for 2008 was revised downward to plus 0.4%. In the current revision, GDP growth for 2008 is now listed as 0%. Perhaps after another 15 to 20 revisions it will get to a more reasonable number. The history of 2008 GDP indicates the U.S. can overstate its GDP by a total of 6% to 9% in its initial reporting. Keep that in mind when you read that GDP was up 2.4% last quarter.

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