In case you managed to miss it, the GDP revision on June 25 was stunningly bad. The contraction was 2.9%, revised downwards from 1%. This was both the biggest fall since the fourth quarter of 2008, when GDP fell by 8.9%, and the largest revision of the second GDP estimate since the inception of this report, in 1976.
The Washington Post gave a good overview:
But this recovery has a way of moving out of reach just when we think we’re getting close. The International Monetary Fund and the Federal Reserve have already pushed back their forecasts for liftoff from the grinding economy to next year. The new reading of first quarter GDP could move the ball even farther. A 3 percent annual growth rate is starting to seem like the promise made by the White Queen in “Alice in Wonderland”: Jam tomorrow and jam yesterday, but never jam today.
Particularly disturbing in this revision was the downgrade in consumer spending. The American shopper was supposed to be the bright spot in this recovery, reliably trudging to the malls and filling their online shopping carts despite government shutdowns and wintry snowstorms. Consumer spending jumped 3.3 percent at the end of last year, and the data initially showed a similarly strong increase during the first quarter. Wednesday’s release showed the cracks in that pillar.
A significant portion of that revision was due to overestimates of how much Americans spent on health care, which has been tricky to measure since the rollout of the Affordable Care Act. But Eric Green, head of U.S. rates and economic research for TD Securities, said that even if those assumptions had been neutral, GDP still would have fallen at a 2.7 percent annual rate. There were other downward moves, as well. The 8.9 percent decline in exports was larger than previously reported. The buildup in inventories was a slightly bigger drag on growth, subtracting 1.7 percentage points.
“In short, GDP was recession-like in Q1, although most other data clearly signal that the decline is an outlier,” wrote Jim O’Sullivan, chief U.S. economist at High Frequency Economics.
Recession-like. It is astounding that we are using any variation of that word five years into the recovery.
Now after getting rattled, Mr. Market shrugged off the report. So what if we opened Schrodinger’s box and found out the cat was dead? That was first quarter’s cat. That cat might as well be dead for all we care now. Plus the weather was bad, so we’ll make all that up, and anyway, the Fed has our back, so if there really is something to worry about here, they’ll fix it, as least as far as security-owners are concerned.
Hedgie Scott was not convinced by various pundits’ efforts to shrug off the sobering news. I’ve omitted names so as to protect the guilty. From Scott’s e-mail:
If Q1 was truly simply seasonal, then we’d make a great deal of that back once the weather improved. That would argue, given the forecasts at the beginning of the year, for Q2 growth of at least 6%, to get us back on that track, but the kneejerk raises of Q2 estimates that we got today—Barcap and Goldie are what I saw—didn’t come close to that.
And the “data” cited showing that yes, we are seeing precisely that comeback, are suspect in many ways, in my opinion. First, the PMI. I can only do this anecdotally, at the moment, but on that basis there’s been a clear divergence between survey data, primarily the PMI and ISM, though the same is emphatically true of the IFO as well, and the harder data from series like GDP, so that the usefulness of those surveys in predicting how the economy actually performs has diminished appreciably. I suspect the surveyed are influenced to a much greater extent today than formerly by the media’s equating of stock market performance with the performance of the economy, and as a result the surveys yield more optimistic views than the later hard data are able to support. We then have the discussion of low jobless claims. Again it seems to me that we may absolutely have fired everybody we’re going to fire, and once all the dead wood has been cut, and you’re operating as lean as you can, jobless claims level off at a relatively low number, as they have. But there’s a big difference between that and the kind of economy that produces lots of well-paying jobs, which we clearly do not have, and don’t seem to be getting a lot closer to. Moreover, jobless claims have been in a range for longer than simply Q1, and Q2 hasn’t seen a “big comeback” in them. I don’t really know much about the rail gains, so I’ll leave that one alone. As to the housing data, as simply one example, the white hot May new home sales were mostly driven by the southern region—266K homes in the south. Unfortunately for the bullish spin on this, that data did not reach the level of statistical significance, plus 14.2% with a 90% confidence interval of +/-27%–meaningless, in other words, pending better numbers.
And yes, markets are forward looking, but at some point that argument loses force, does it not? Contracting economic growth, aka recessions, are horrible for corporate profits (as Q1 profit data showed), and continually rising stock prices in the face of falling earnings catches up to you eventually.
Before this morning’s data, GDP growth from 2007 until today was 0.7% annually; that number gets revised lower after this morning’s data. Can we postulate that the trend rate of growth has slowed, and that thinking about a 2.5% trend rate can not be justified any longer, that even 1.5% as a trend growth rate is certainly not pessimistic? And given the rate of capital investment in the country, there’s little reason to forecast that to change, as far as I can tell. Pimco’s new normal description seems pretty accurate to me.
As to the assertion that it would be a mistake for the Fed to tighten, well, the only issue I have with that is that there’s no evidence I can see that its current policy has helped the economy one iota, except on the shortest of time frames, and, the problem with arguing counterfactuals aside, I can see lots of ways in which it has hurt, if the goal was to put the economy on a sounder footing for the long term.
The problem that realists like Scott have had for some time is that it has been an objective of Fed policy to elevate asset prices irrespective of the state of the economy in the hope that they would lead a recovery. We can see how well that has worked: splendidly for the 1% and not at all for everyone else. But as Scott indicates, presumably at some point investors will want to be owning eating sardines rather than trading sardines*, but when that happens is anyone’s guess.
But I though this contrast between the sobering data and the insistence by most investors and analysts that this GDP report was a one-off and didn’t dent the outlook would serve as a basis for a reader sanity check. What do you see in your economy? Do conditions seem to be better, worse, or mixed? And what data points do you have to support your views?
Manhattan is so appearance-obsessed that it is hard to tell what is going on except when conditions are extreme. On the one hand, real estate prices continue to march upwards, but foreign investment has become such a large factor that it is impossible to judge what trend would be like absent that. On the negative side, I haven’t seen so many vacant retail stores since the very worst of the downturn. One sad example was a terrific Persian restaurant (best lamb I’ve ever had and at reasonable prices) that didn’t make it. The explanation I’ve heard is that commercial landlords held off on rent increases after the crisis and finally started putting them through. But if conditions aren’t so hot, why should landlords assume they can actually come out ahead by putting through a rent increase? There are storefronts that have been empty for more than four months, with no sign that anyone has signed a lease and is doing pre-move-in fitting out.
Similarly, the vibe I get at my moderately upscale hair salon is that conditions there are flattish, and that the hairdressers are not hearing a much in the way of economic confidence from their customers. A lot of women professional went to a less frequent hair cutting or coloring schedule during the downturn, and there don’t seem to be many that have gone back to a more frequent maintenance schedule.
Again: how is your economy doing?
* From a classic Wall Street joke. On a slow day, some market-makers decide to start trading a can of sardines. Trader A starts the bidding at $1, B quickly bids $2, and several transactions later, E is the proud owner of the tin for $5.
E opens his new purchase and discovers the sardines have gone bad. He goes back to A and says, “You were selling rotten sardines!”
A smiles broadly and says, “Son, those aren’t eating sardines. They are trading sardines.”
This piece is cross-posted from Naked Capitalism with permission.