Analysis of Weak GDP Report and Fed Talk the Talk

by the Curmudgeon


Real gross domestic product (GDP) -- the value of the production of goods and services in the United States, adjusted for price changes -- slowed to an annual rate of 0.2% in the first quarter of 2015, according to the "advance" estimate released by the Bureau of Economic Analysis (BEA).  That's compared to 4Q-2015 real GDP which increased 2.2% and 3Q-2015 real GDP growth of 5%.  The 0.2% GDP increase was the weakest number in a year, but was actually much worse than reported.


Reuters noted that economists’ claims that the weather in February knocked a half-percentage point off GDP growth, that the West Coast ports dispute knocked off 0.3 percentage point, and that the drastic 48% drop in spending on mining and drilling equipment was a result of “front-loading” the cuts into the first quarter.  How long are we going to hear excuses like that from economists after disappointing U.S. economic reports?


A few nuggets from the BEA GDP report:


·                 The change in real private inventories added +0.74% to the first-quarter change in real GDP after subtracting 0.10% from the fourth-quarter change.  ZeroHedge says the $121.9 billion increase in private, mostly nonfarm, inventories in the first quarter was the biggest inventory build in history. They wrote, "...if US inventories, already at record high levels, and with the inventory to sales rising to great financial crisis levels, had not grown by $121.9 billion and merely remained flat, U.S. Q1-2015 GDP would not be 0.2%, but would be -2.6%."

·                 Personal consumption expenditures slowed down to an inflation-adjusted 1.9% increase, but that still added +1.31% to the change in GDP.

·                 Real final sales of domestic product -- GDP less change in private inventories -- decreased 0.5% in the first quarter, in contrast to an increase of 2.3% in the fourth.

·                 The deceleration in real GDP growth in the first quarter reflected a deceleration in personal consumption expenditures, downturns in exports, in nonresidential fixed investment, and in state and local government spending, and a deceleration in residential fixed investment that were partly offset by a deceleration in imports and upturns in private inventory investment and in federal government spending.

·                 The implicit price deflator was reported at a -0.1% annualized inflation rate in first quarter (see Brent's comments below).  Note that BEA reporting real (inflation-adjusted) GDP growth of 0.1% would have left nominal (not-adjusted-for inflation) growth at unchanged. 


In a note to ShadowStat subscribers, John Williams wrote: "The Bureau of Economic Analysis (BEA) has tremendous leeway in the level of growth that it reports in its first or "advance" estimate of headline GDP growth in a given quarter.  Usually, the BEA attempts to target the initial headline growth estimate to consensus expectations, moving the internal BEA estimate towards the consensus number.  Where the consensus appears to have been about 1.0% coming into this morning’s (April 30th) report, and where the BEA gave a 0.1% headline growth estimate—the lowest positive growth rate possible—the message was negative as to what the BEA was seeing in reality.  The internal BEA estimate probably was for a quarterly contraction, and the message from the BEA to consensus forecasters likely was that the numbers were worse than they appeared, and that downside revisions are pending."


"Avoiding negative or unchanged GDP growth headlines, the BEA likely applied its "minimal" positive-growth guidance to the nominal number as well, which pushed the minimal real growth up by 0.1% to a headline 0.2%."


The complete GDP report is available here. 


Fed Statement on GDP Slowdown:


Here is the FOMC Statement from today (emphasis added): 


"Information received since the Federal Open Market Committee met in March suggests that economic growth slowed during the winter months, in part reflecting transitory factors. The pace of job gains moderated, and the unemployment rate remained steady. A range of labor market indicators suggests that underutilization of labor resources was little changed. Growth in household spending declined; households’ real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high. Business fixed investment softened, the recovery in the housing sector remained slow, and exports declined. Inflation continued to run below the Committee’s longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable."


Brent Berarducci on Energy Price Decline: Job Cuts far Outweigh "Tax Cut":


One area that continues to be misinterpreted is the effect on the economy of the oil price decline last fall.  The conventional wisdom (almost always incorrect) held to its view that falling gas and energy prices acted as a "tax cut" to consumers and that stronger economic growth was just around the corner. While there may have been substance to that hypothesis decade(s) ago, it is definitely not the case today.


Upstream energy exploration and production is among the best paying sectors in America.  A hard working high school graduate was paid $76,000 annually (plus substantial health and retirement benefits) as an entry level floor hand on a 1,000+ horsepower drilling rig this time one year ago.  Oil rig managers were earning $125k+. Those jobs have been substantially cut in the past 6-9 months. This does not include completion and production hands being let go and service sector companies including names like Haliburton and Weatherford that are laying off folks by the thousands.


The massive job cuts from the energy sector, which is arguably the only sector that has experienced meaningful growth since 2009, far outweigh any perceived tax cut from lower prices at the pump.


Considering the burdens of the Affordable Care Act (ACA or "Obamacare") and the most progressive income tax structure since the late 70’s, there should be no shock whatsoever that we are faced with the possibility of another recession and deflation.


Right now you may be asking “deflation”? Yes, deflation and the timing of the GDP report is key, given the FOMC meeting concluding this afternoon.  (See statement excerpt above)


One of the key metrics the Fed follows to gauge inflation is the Implicit Price Deflator for Gross Domestic Product. This somewhat arcane metric may be found in Table 6 of this morning’s report from BEA.


Please note that thanks to the manipulated inflation policies of the Federal Reserve this metric has increased almost every quarter since 1990. The two exceptions are in 2009 and in today’s Q1 2015 GDP report (see above bullet point).


I think we can take a short-term rate increase in June off the table and barring some unforeseen explosion of economic activity probably take any short-term rate increase off the table this entire year.  And with 2016 being an election year, probably all of next year as well.


Curmudgeon's response:  QE4 anyone?


Victor's Closing Comment: 


A 300 pound man walks around and barely functions.  His doctor tells him he must lose weight.  The fat man pays no attention, nothing changes, and suddenly he dies of a heart attack.  Are we surprised? This is the state of the world today!  


When the world economy and global stock markets die, it will be very sudden and a shock to most (but not to readers of the Curmudgeon columns).


But when the "fat man" is dead.... blood will run in the streets.  You've been warned."


Till next time...


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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