Fourth Quarter GDP: There's Your Inventory Bounce

Jan.29.10 | About: SPDR S&P (SPY)

Fourth-quarter gross domestic product is out with a stunning 5.7% annualized rate of increase. Let's look inside and see if the numbers make sense: [Emphasis mine]

The increase in real GDP in the fourth quarter primarily reflected positive contributions from private inventory investment, exports, and personal consumption expenditures (PCE).

The first two are not a big surprise. The latter, however, is dangerous to rely on.

As I have repeatedly pointed out, the United States has added about $500 billion (annually) in transfer payments to the federal budget during the past 18 months. This counts in the GDP report as PCE, but this is not actual output any more than I am richer if I go to the bank and borrow $20,000 on my credit card.

If one was doing GDP as a "balance sheet," you would have to subtract the addition in liabilities (debt) from the money spent, but of course GDP isn't computed that way. This results in a nutty overstatement of GDP when it is used as a measurement of economic health, which of course is how all the so-called "economists" use it.

Indeed, that $500 billion is an annualized distortion of a whopping 3.57% of the entire economy!

There are some problems in this report as well. The claim is made that real federal government expenditures and investment was flat (0.1% increase) vs. an 8% annualized rate of change in the last quarter. I'm not sure I believe that either - but it may in fact be true in that the aforementioned $500 billion diversion could reasonably be "all there is" in terms of what the government can and does spend. I'm particularly skeptical of this number after seeing the durables report and change in defense spending - those two numbers don't add correctly, and defense spending has been up strong all year (much to the chagrin of those who thought Obama would be drawing down our military spending and bringing the troops home!) State expenditures are down as expected (the states are broke!), but the change is small despite all the bleating about lack of money. You would think there would be real cutting going on given the screams of distress - but, nope!

Export growth continued as did imports, but the import growth rate slowed dramatically from the third quarter. The latter mostly appears to account for inventory additions, which was 3.39% of the GDP increase - about what I expected. While this is additive to GDP, it is not indicative by itself of economic strength. More is required: Specifically, we need to see that 3.39% taken up in final demand in coming quarters, otherwise it turns into a millstone around the neck of merchants that will instead destroy profit margins. Nonetheless, industry appears to have "taken the bet" on an economic recovery that actually takes hold.

The amusing part of the report is found in the personal income and outlays section:

Current-dollar personal income increased $119.2 billion (4.0 percent) in the fourth quarter, compared with an increase of $35.1 billion (1.2 percent) in the third.

Personal current taxes decreased $11.7 billion in the fourth quarter, in contrast to an increase of $3.5 billion in the third.

Got it? People aren't earning the money, the government is handing it out. You don't pay taxes on government handouts, for the most part. There was a potential "improvement" signal in the third quarter related to tax liabilities increasing, but that has now reversed - hard - which throws a big fat rock at the concept of employment turning in any meaningful way. Instead, the "current dollar income" is being borrowed and given away by the government through unemployment extensions and other forms of handout.

Non-residential structures (commercial R/E) plummeted by 15.4%, yet residential is claimed to have increased. Homebuyer tax-credit incentives? Probably.

Looking at the breakdown, there are some warnings: Utility expense appears to be comparatively strong, which looks to be the lion's share of the Q4 household service change, with the rest being almost all in health care costs. This is not a good trend when an increasing percentage of personal income is comprised of government handouts.

Non-durable purchases were up significantly at bars and restaurants (normal during the 4th quarter - look at '06 and '07), while gas and energy purchases were down in Q3 and Q4 - a not-good change considering the trajectory of prices for both (demand is decreasing significantly, as prices have been up a LOT, so if gross sales are slightly down.....)

The revisions to this report should be interesting. Remember that the last quarterly GDP report was revised downward some 40% over time. I've archived this copy privately on The Market Ticker so as to preserve any "accidents" in this regard.

Bottom line: The market liked it (although the net change after thinking about it for a while was pretty much a non-event - we're up a whole two S&P points a half-hour after release), but most of the improvement was due to inventory build and transfer payments from the government (and the government borrowed the money), not actual earned income,