The U.S. GDP report for the first quarter of 2009 was pretty awful. GDP came in much worse than expected at an annualized -6.1% below Q4. Here are a few data points (all referencing real GDP data):
- The numbers were much worse than expectations of -4.6 to -4.7%
- The -6.1% comes on the heels of a -6.3%, the worst back-to-back quarters since the recession of 1957-58
- Year-on-year, we have seen a decline of 2.6%, the largest since 1982
- Non-residential investment was down 38%
- Non-residential construction was down 44.2%, the most ever.
- Exports were down 30%, the biggest decline since 1969
I could go on. The general consensus seems to be that this is confirmation of an economy falling off a cliff. But is that really true? Let’s parse the data.
First, I should note that I am going to use nominal data because I prefer not to have my data distorted by the GDP deflator (See my post, “The GDP Deflator” for the reason why). Also, I am not going to use any graphs. I apologize in advance — I just don’t have the bandwidth. But EconompicData has some nice graphs here, here and here).
Now, to the data.
Two months ago, after the Japanese released their Q4 data, I said the following (emphasis added):
Japan’s GDP number is important for a number of reasons. First, despite massive stimulus – economic and fiscal, Japan has never fully rebounded from the stock and property market crashes that began nearly two decades ago. While one cannot rule out demgraphic shifts as a major reason for the economy’s continued sluggishness, the Japanese experience reinforces the notion that stimulus is inadequate without a robust financial sector policy response.
In addition, just as in the U.S. Q4 numbers, there was a significant inventory build in the figures which artificially goosed the final figure. The GDP number would have been even worse were it not for the inventory build. Given the massive layoff announcements in Japan and elsewhere, it is evident that companies are looking to reduce inventories drastically in Q1 2009, that is going to depress GDP figures. I expect a serious downside surprise in Japan and the United States at a minimum. Such a nasty surprise could have an important psychological impact for markets and consumers.
Now, I may have underestimated the market’s ability to ‘see through’ the data (the market is rallying today). However, clearly the consensus was much too bullish as I predicted. And the main culprit was inventories, which were purged at a $136.8 billion annual rate. That is enormous. In fact, Q1 2009 saw the largest inventory purge ever. As a percent of GDP, you have to go back to Q4 1982 to get a more liquidationist reading.
What about the other major components of GDP? Below is my read of each (all data here is nominal):
- Nominal GDP. Nominal GDP itself decreased at a 3.5% annualized rate versus Q4. This compares to a 5.8% decrease in Q4 2008 over Q3 2008. Translation: the nominal slowdown was much less in Q1 than Q4 2008. The similarity in Q4 2008 and Q1 2009 real GDP data is explained wholly by changes in the GDP Deflator (there was a huge increase in the price index for non-durable goods in Q1).
- Consumption. It held up just fine. Personal consumption is still running at 70% of GDP. That’s up from about 62-63% in the mid-1970s. This number must come down because America has been over-consuming. The fact that it has not come down suggests that average GDP growth over, say, the next decade will be weak.
- Durable Goods. -10.0%. It was -12.0% in Q4. These are big declines meaning big ticket items like autos are not being sold. But, nothing more really important to see here.
- Non-durable goods. -4.7& down versus 2.3% in Q4. To me, this does indicate that consumers are not spending as freely.
- Fixed Investment. Down 17.5% versus 8.0% in Q4. That’s an enormous change driven by huge declines in both residential and non-residential investment. The question is what does this mean for Q2-Q4. Nominal residential investment is at its lowest since 1998. Non-residential is at its lowest since 2005. This suggests that the decline in residential investment will slow but that the rapid decline in non-residential investment will continue. As an example, non-residential investment first hit an annualized $1 trillion in 1998. It is now $1.3 trillion annualized. So a 30% decline gets you back to 1998, where non-residential is. That takes $300 billion off GDP.
- Inventories. I’ve already said my piece here. The purge will continue into Q2 and Q3 (GM is idling production in Q3). To me this speaks to a huge upside surprise in Q4 and Q1 2010.
- Trade. Both exports and imports are plummeting. But, the U.S. imports far more than it exports right now. So, this decline serves to make a negative number, less negative. I see this trend continuing. Translation: a trade collapse will help to increase GDP in the U.S..
- Government. Slightly negative. Largely a non-issue.
On the whole, I would say that this report does not support the ‘falling of a cliff’ meme. Just looking at the rate of nominal GDP decline, Q4 2008 probably marks the low point for the cycle. Commercial real estate, inventories, durable and non-durable good will be a drag. But, you can see from the preceding analysis, that some of these numbers are hitting decade lows or multi-decade rates of decline.
In looking at GDP, we should remember that we are not reporting the stock but the flow. Because of the declines we have already had, we are starting from a lower base (residential investment is a perfect example). It is unrealistic to think that these declines can continue at the same pace. I would argue that, given the rate of decline, we will probably see a bottoming for residential investment and inventories by the end of the year. As a result, I continue to expect upside surprises in the later part of the year.