Don't Be Fooled by the US GDP Report

While it seems like US GDP is on a rollercoaster, the underlying strength in the economy is pretty clear if you look carefully enough

Robert Johnson, CFA 4 February, 2013 | 1:55PM
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As I warned in my last column, there was indeed economic news for both the bulls and the bears to feast on this past week. On the surface, the negative US GDP growth report was a disaster. The GDP growth rate shocked everyone with a 0.1% decline--although closer examination suggests that government bill payers and overly cautious businesses were largely to blame for an otherwise excellent report.

In housing news, falling pending home sales and increasing Case-Shiller Price Index readings were part and parcel of the same issue: not enough inventory of American homes, new or used. In fact, the new biggest threat to my economic forecast is that there aren't enough land, materials, or labour to truly step up housing starts.

While the January US employment report was satisfactory and proved that no one panicked in the first month, the real news was a massive adjustment to the employment database, suggesting that we added hundreds of thousands more jobs to our economy over the last two years than was previously thought. Still, we have recovered just 5.5 million of the 8.7 million jobs lost during the recession and are only adding jobs at a 2.1 million annual pace. Though manufacturing isn't generally important enough to move the economic needle, news this week was surprisingly and uniformly positive. Excellent auto sales for January should also prove to be encouraging news for the economy and the manufacturing sector.

GDP Probably Not Worth the Analysis
The GDP report was a bit more confusing and convoluted than even I had hoped. And I was wrong, too, which always hurts. In fact, I didn't even get the direction right. However, I would suggest that the report has potential to move from negative to positive with two upcoming revisions. The first version of the report suggests the economy shrank 0.1% in the fourth quarter versus growth of 3.1% in the third quarter. This missed consensus forecasts for 1% growth, and my more optimistic 1.5%.

While I identified the government as a key potential detractor from the report well over a month ago, I wasn't even close to the magnitude of the impact. Inventories were the other big surprise in the report, further reducing GDP. Businesses appear to have failed to keep up with the pace of consumer spending, and they will have to make up for that in the months ahead.

GDP Report on a Roller Coaster, Real Economy Not So Much
The GDP report probably deserves a little context for those who don't deal with this grab bag of statistics on a regular basis. The table below shows the extreme volatility of the report and the almost universal phenomena of a bad quarter following a great quarter and vice versa. See if you can't discern that very trend in the table below:

Picking Apart the GDP Number: Slow Government Spending and Inventory Shrinkage Overwhelms Great Consumer Data
Consumption grew a quite remarkable 2.2% (and represents 70% of GDP), far exceeding the 1.6% rate of the third quarter. Business investment, another important marker, also did far better than expected, growing by about 8%. Not bad for the cliff-obsessed business community (turns out that maybe the media was more obsessed than either consumers or businesses).

Housing did better than anticipated, growing 15%, its best showing of the recovery. The thankfully not-too-big government sector (20% of GDP) had shrunk an almost unprecedented 6% (of course, that is 1.5% for the quarter multiplied by four to get to an annual figure--perhaps exaggerating the effect). Looked at another way, slower government subtracted 1.3% from the GDP calculation. Inventories, another sore spot, also took away 1.3% from the GDP report. Net exports didn't have nearly the impact that many had feared, subtracting a mere 0.25% from GDP. 

Nothing from the report dissuaded me from my general optimism about the US economy for the year ahead. My only fear is that it spooks reporters and consumers. I fielded at least a half-dozen reporter calls wondering if markets had gone mad with GDP down and the Dow touching 14,000 in the same week. Actually, the markets took the seemingly bearish but actually bullish GDP report in relative stride, and made the correct interpretation.  However, the bears will have the data at their back, at least for a few weeks. Bad weather, a bad GDP report, a temporary shortage of home inventories, and the increased payroll tax and tax refund delays are all likely to weigh on upcoming economic reports. These reports are likely to make it appear that the bears have the upper hand. Don't be fooled. The underlying strength in the economy is pretty clear if you look carefully enough.

Employment Report Contradicts Week GDP Report
Meanwhile, the key takeaway from the latest US employment report is that employment growth was exceptionally strong in the fourth quarter, something that would seem highly unlikely given the weak showing in the GDP report. Also, the government finally found at least some of the missing construction workers (which had previously failed to show up in employment reports despite accelerating housing starts). This and a huge revision in retail sales workers caused the government to sharply revise total employment growth for 2012, as shown in the table below:

The scope and variety of revisions make much of a detailed discussion of the month-to-month data nearly worthless. That said, construction and retail were standout performers while most other categories didn't show meaningful changes and were close to recent averages. Courier services, a volatile and difficult to calibrate category, produced an outsized decline of almost 20,000 jobs, which is likely to be reversed in the months ahead. The government lost employees yet again, this month losing 9,000 jobs. While long-term construction and retail numbers were revised upward, government took a meaningful hit in the revised data set. I am not particularly hopeful that government employment will look much better in 2013. Changing gears, cold weather didn't help the January employment results, either, especially compared with a year ago. Discouragingly, it doesn't look like February is going to be much better, weather-wise.

The January US employment data was not as good as November and December with slower overall growth rates, flat hours worked, and better wages per hour. However, I am not a big believer in the huge November spike of 256,000 jobs added. I don't think we had this huge increase (in the face of an unresolved fiscal cliff) and then stumbled in December and January when the cliff issues were at least temporarily pushed aside. Rather, I think you need to look at a combined three-month period of data, as I have in the table above.

The original version of this article was written for a US audience and published on

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Robert Johnson, CFA  is director of economic analysis with Morningstar.

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