Recalibrating after the 1% fall in US GDP
US GDP fell 1.0% in Q1 2014 according to the revised estimate released by the the US Bureau of Economic Analysis. A sharp downward revision was expected but this revision was unusually sharp and calls into question the continuing meme that the US economy slowed merely because of weather.
Let’s look at some of the numbers and then put this in context. As I wrote on Thursday, the peak for growth this cycle was 4.1% annualized in Q3 2013. This was followed by 2.6% growth in Q4 2013. Both of these numbers were flattered by inventory changes and a lower number for Q1 should have been anticipated from the outset. But nothing could have prepared us for the numbers we are now getting.
We saw GDP decline at an annualized 1.0% rate, with gross domestic income declining at an even higher 2.3% rate. These are very bad numbers, even worse than the 0.7% decline number I quoted from Goldman on Tuesday. Here’s the thing though. Underneath the numbers, the data are less dubious.
Inventories. First, all of the change was due to inventories. Instead of subtracting 0.57% from GDP in Q1 as the preliminary GDP estimate said, this second estimate shows inventories subtracted 1.62% from GDP. In Q4 2013 and Q1 2014, I was worried about the inventory trend’s potential impact on growth, jobs and business investment.
In March, for example, I wrote that “If job and wage growth declines significantly over a six- to 12-month period while inventories are too high, the result is a loss of consumer demand that brings on an inventory purge which results in a downturn that can snowball into a recession”. We now have the inventories purge – but without the job loss. That’s good and means recovery can continue on a more sustainable basis.
Jobs. The unemployment rate has been coming down and non-farm payrolls have been increasing steadily. My favorite time series is jobless claims. And the claims data came out at the same time as US GDP numbers, showing a decline in the 4-week average initial claims to 311,500, the lowest level since 2007. Now, I have been saying that claims are in jeopardy of surpassing last year’s already low level because they can’t go much lower, which would be a drag on growth. But they are staying low – and that’s bullish for household income and consumer spending.
Consumer spending. In Q3 2013 when GDP rose the most, the consumer spending time series was showing weak growth. Real personal consumption expenditures advanced only at a 2.0% annualized rate. But consumer spending has picked up in 2014 as releveraging has become a big factor. The third estimate for Q4 2013 PCE growth was 3.3%. And this last estimate for PCE growth in Q1 2014 was 3.1%, which is actually a bit better than the first estimate for Q1 from April. So we are now seeing personal consumption in the US growing at a 3%+ annualized rate – despite the drop in GDP.
Business investment. In Q1, real nonresidential fixed investment decreased 1.6%, which is in stark contrast to the increase of 5.7% in Q4 2013. So the jury is still out on the business capex story. If the jobs picture holds, I would expect the business investment time series to move up as well.
Where I come out of all this is that the US is still in a 2%ish growth phase for 2014. The Q1 numbers were dragged down by weather and are not reflective of the underlying trend. I expect the US economy to pick up from Q1 but 2% growth for 2014 is not robust, it’s middling.
On the downside here is the fact that gross domestic income fell 2.3%. GDI represents all of the income that can be derived from production, but strips out some of the noise like inventories. That could mean that earnings are now starting to contract. And indeed, corporate profits for Q1 were down, and down a big 13.7%. Forecasts had been for +0.4%.
Putting this all together, it says the US economy should continue to chug along with a slight acceleration that gets us to about 2% growth for the full year. The job picture will continue to improve. But the GDI for Q1 is worrying in terms of corporate profits – and profit margin mean reversion. If Q2’s numbers confirm the basic trend of middling but improving growth coupled with job gains and profit falls, we should expect the markets to react negatively in the late summer and early fall. But, the real economy picture looks relatively good in the US.