GDP - Pre/Post Annual Revisions In Pictures

by: Lance Roberts

The first estimate of GDP for the second quarter of 2014 came roaring in at 4% annualized growth. The following is an initial analysis as written by Neil Irwin from the NYT:

First, here's the overall growth number. As it shows, the 4 percent rate of economic expansion in the April-through-June quarter was the strongest since last summer and the third-strongest quarter in the expansion that began five years ago.

But there is an important qualifier. Of the 4 percent reported growth, 1.66 percentage points was attributable to businesses increasing their inventories. But when companies make more goods that end up on store shelves or in warehouses (and not because they're selling more stuff), that doesn't tell us much about the future of the economy. So economists often look at 'final sales,' excluding inventory effects, to get a sense of the true underlying pace of growth."

This is a good piece of analysis which provides a good starting point for discussing the current state of the economy. The latest release of data also included annual revisions. These revisions are almost always overlooked by analysts since they are "past history" but provide an interesting perspective on how far the estimates have been away from reality. The charts below show both the pre- and post-2014 revisions to the data to provide some context to the economic strength/weakness debate.

Real Final Sales

Neil is correct, real final sales can tell us much more about the state of the economy than just headline GDP. In the latest quarter, final sales of domestic product rebounded 2.3 percent after dipping 1.0 percent in the first quarter. However, as shown below, real final sales on an annual basis actually declined near levels that are normally associated with recessionary drags in the economy.

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As shown, real final sales were weaker than originally forecast in 2012, however, 2013 was revised up to stronger sales. Importantly, the decline in real final sales in the Q4 of 2013 and Q1 of 2014 has been substantially worse than originally thought. This sharp decline in real final sales is a primary contributor to the build in inventories. Companies have been producing products, which has boosted production numbers, but consumption has been weak.

Gross Domestic Income

Another very important factor of economic strength is gross domestic income. Gross domestic income is the total income received by all sectors of the economy and includes the sum of all wages, profits, and taxes, minus subsidies. Decline is gross domestic income, as shown in the chart below, have also been very indicative of forthcoming weakness in economic activity.

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Furthermore, when gross domestic incomes are viewed on an annualized basis the weakness in income becomes readily apparent. As opposed to real final sales which were revised stronger in 2013, gross domestic incomes were revised down. Currently, the annual rate of change of gross domestic incomes is at levels normally associated with economic weakness.

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The issue of income is crucially important in an economy that is nearly 70% driven by personal consumption expenditures (PCE). While there are many analysts hoping for a "revival in business spending" to boost the economy, it is unlikely that a sector that comprises roughly 15% of the economy can overcome the drag from consumers that comprise nearly 70%. Furthermore, businesses will only aggressively spend on fixed investments when consumer demand is growing beyond their capacity to meet it. The data suggests that those "hopes" may be somewhat misplaced.

The chart below shows the revisions to overall PCE as well as the subcomponents of spending on services, goods, durable goods, and non-durable goods. As you will see, personal consumption expenditures were vastly weaker in Q1 than originally estimated. Unfortunately, the expected strong rebound in spending did not show up in Q2. There is a substantial bit of evidence that this number may be revised down over the next two months as well.

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Spending on services, which is the largest component of PCE declined in the second quarter while durable and non-durable goods picked up. Increased automobile sales due to sub-prime auto loans boosted durable goods orders, but this is likely a transitory effect.

Overall, the economic "growth story" is really more of a "struggle along" story. Economic growth has been fairly steady over the last few years but not strong enough to stand on its own without ongoing monetary interventions from the Federal Reserve. The chart below shows overall "real" GDP both pre- and post-revisions. The economy is currently operating at levels that were only seen previous to the last two recessions and is at levels that leave little "room" to absorb an exogenous shock.

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However, sometimes the issue is that, as economists and analysts, we really get "too close" to the data to fully appreciate the longer-term trends. If we step back and take a long-term view of the data, a very different picture emerges. (The 6-panel chart below ONLY uses the revised 2014 data.)

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In order to put economic data points, such as today's 4% GDP print, into context we must view the overall trend of the data. All of the primary drivers of the economy from savings, which leads to productive investment, to consumption and production, are all in negative long-term trends.

While there are no indications of an immediate recession, there is also no real sign of an economy that is on the verge of acceleration. As stated earlier, most of the economy is running at levels that leave little room to adjust for a geopolitical shock, natural disaster or another financial upheaval.

Overall, the revisions to the annual GDP data were mostly a wash as 2012 was weaker than originally thought and 2013 was a little stronger. Furthermore, I think that the revisions over the next two months will revise Q2 down closer to 3%. The latest Gallup economic confidence poll shows a sharp downturn by consumers and an overall decline since June.

This also suggests that the rebound in Q2 from the sharp contraction in Q1 may not be sustainable going into the end of the year. That weakness combined with the extraction of Fed liquidity, as discussed yesterday, could lead to sluggish market growth into the end of the year.