- Amid a flurry of economic releases, the revision to real GDP which brought it into contraction territory received the most attention.
- Faulty seasonal adjustments were to blame; but so were other (transitory?) factors.
- Growth is weak; but leading indicators suggest a recession is still a low-risk proposition.
Although last week was shortened by the Memorial Day holiday, it was busy on the economic front. Last in, first out: The expected downward revision to first quarter real (inflation-adjusted) gross domestic product (GDP) brought it into negative territory, for a reading of -0.7%—albeit better than the -0.9% consensus expectation. More on that in a minute.
Other than GDP, the economic data was mixed-to-better: Of the 23 indicators released last week, 15 came in at-or-better than expectations; while eight were weaker.
And we’ll be swamped with data coming out this week; with 32 indicators on the calendar, including jobs on Friday, and both the manufacturing and services ISM reports. As I put the finishing touches on this report, the ISM Manufacturing Index was just released and it moved up to 52.8 from 51.5. And construction spending also came in better than expectations at 2.2%, well above the 0.7% consensus expectation. Both are welcome good readings.
The downward revision to real GDP into negative territory has received the most attention given the chatter around supposed-faulty seasonal adjustments—addressed initially in a San Francisco Fed report, and subsequently conceded to by the Bureau of Economic Analysis (BEA), the body that calculated GDP statistics. The BEA has announced they will release a revision to the first quarter reading in July; with the consensus of economists at about a 1.5% lift; which would take the reading back into positive territory.
A cursory glance at recent years’ quarterly GDP readings has suggested something was amiss.
Source: Bureau of Economic Analysis. *3Q09-1Q15. Real GDP based on annualized Q/Q % change.
Notice in particular that over the past 10 years (which includes six years of the current recovery/expansion), real GDP has a negative average for the first quarter. Even since the recession ended in June 2009, real GDP has gone into reverse three times in the first quarter; including in both 2014 and 2015—last year’s first quarter was -2.1%.
Not just faulty seasonals though
Leaving the seasonal adjustment problems aside for a moment, there were fundamental factors at play in the dip in growth—most of which are likely transitory—including severe winter weather, the west coast ports strike, the plunge in oil prices and the surge in the US dollar. Keep in mind, the first quarter 2014 -2.1% rate was followed by 4.6%, 5.0% and 2.2% in the second, third and fourth quarters, respectively.
As is always noted in this business, past performance is no guarantee of future results, but a similar pattern could emerge this year. High Frequency Economics (HFE) looked at some interesting details behind the headline number.
GDI telling a better story
The gross domestic income (GDI) data, also released last week, was up at a 1.4% annual rate in the first quarter—not strong, but better than the real GDP decline. In theory, “tax return-derived” GDI and “expenditure-derived” real GDP are identical; but in practice they can diverge, reflecting different data sources. That said GDI has also become more reliable as the lag time for obtaining comprehensive income tax records has shortened in recent years.
Fourth quarter 2014 GDI was revised up to 3.7% from 3.1%, which was already a lot stronger than the 2.2% reported for real GDP. Over the past four quarters, real GDI is up 3.6%, almost a point stronger than the 2.7% reported for real GDP. And, the GDI data is more consistent with the still-healthy employment data.
As an aside, the upward revision to fourth quarter 2014 GDI reflected the incorporating of comprehensive unemployment insurance tax records that just became available according to HFE. This data resulted in nominal wage income growth being revised up to 6.4% at an annual rate, from 5.2%. And it’s expected that first quarter 2015 wage income growth will be revised up in three months’ time as well when tax records become available. This is important as it relates to Federal Reserve policy; and we maintain our view that the Fed may begin raising short-term interest rates in September.
Recession risk still low
None of this is to suggest the US economy is strong; just that the weakness in the first quarter is not likely a sign of heightened recession risk; which certainly would have implications for stock market performance. The longest recovery/expansion in history was the 10 years beginning after the 1991 recession—so the fact that we’re six years into the current upcycle, it’s not a stretch to say we are in a more mature phase.
But GDP in any form is a lagging indicator; which is why it needs to be reviewed in conjunction with leading indicators; seen below via the Conference Board’s Index of Leading Economic Indicators (LEI).
Leading Economic Index & Recessions
Source: Evercore ISI, FactSet, The Conference Board, as of April 30, 2015. Gray-shaded areas indicate periods of recession.
Barring a near-term deceleration in the LEI, it is set to surpass its prior high in relatively short order. As the chart above shows, once these “round trips” had occurred in the past three economic cycles, a recession was still an average six years away.
This is in keeping with Strategas’ Don Rissmiller’s 5 Reasons There’s Still Time in This US Cycle:
Nonfarm payroll growth has been accelerating. Only after payroll employment growth decelerated for two years (on average) did a recession typically occur. Historically.
Labor’s share of GDP is low, and has only just started to pick up. Labor’s share of GDP typically turned up three yearsbefore a recession historically.
Wage growth (average hourly earnings) is still below 4% year-over-year. Even once 4% wage gains were hit historically, it was over two years (on average) before a recession.
The yield curve is not inverted. An inverted yield curve had almost a one-and-a-half year lead (on average) on recessions historically.
Consumer confidence remains in an uptrend. Sharp drops in consumer confidence typically had a one year lead on recessions historically.
Since the recession ended nearly six years ago, nominal (not inflation-adjusted) GDP has been in a very narrow range between 3.5% and 5.0%. If the GDP price deflator is about 1.0% quarter-over-quarter in this year’s second quarter and real GDP is 2.0% (both are around consensus expectations), then nominal GDP would be just 3.0% at a quarter-over-quarter annual rate. This would represent a paltry 2.7% year-over-year rate. Corporate profits come under pressure when nominal economic growth—which ties to corporate revenue growth—is under 4.0%. The expected and continued weakness in top-line growth, and limited bottom-line growth, is one of the reasons we have a more neutral view of the US stock market this year; especially given slightly elevated valuations relative to history.
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