Less to Q4 GDP Data than Meets the Eye

by: Barry Ritholtz
Bloomberg's Caroline Baum looks askance at some of the recent economic data, and finds it wanting:

The new year started with some old data that suggested the five-year U.S. economic expansion wasn't ready for the retirement home just yet. Holiday sales were decent, only because of deep discounting on the part of retailers. Weekly jobless claims fell to their lowest level in almost a year in mid-January. Manufacturing output rose in December for the first time in four months, but it wasn't enough to prevent a quarterly decline. Even housing, the economy's weakest link, proved that things don't go in one direction forever. The end-of-year bounce in sales and starts was somewhat suspect in the face of unusually warm winter weather.

As the new economic data has been released, the wizards of Wall Street ratcheted up their Q4 GDP forecasts. Consensus started near 2%, bounced up to 2.5%, and is now somewhere near 3%. Does the data actually justify this increase?

Baum says there are good reasons to be skeptical about fourth-quarter growth:

Retail Sales:

  • Consumer spending in Q4 (gains estimated at 4%) was more of a price than a volume effect, achieved through huge discounts.
  • Nominal sales slowed. And nominal sales are the most correlated data series to corporate profitability.
  • Consumer goods prices plummeted in Q4, as a result of massive markdowns. Excluding food and energy, retail prices fell 2.8 percent in Q4 - the biggest decline in 3 years.
  • In other words, Retailers bought sales at the expense of profits. Then there is the suspect GDP data:

    Q4 2006 output measures don't support 3% real GDP forecasts. Goods, Services and Structures suggest nominal output in Q4. Manufacturers' shipments and inventories declined 4.5%, Construction Spending fell 3%, while Services rose 6%. Imports didn't rise in the fourth quarter, and inventories rose at a slower rate than in the third quarter.

    GDP is often measured from the expenditure side (consumption + investment + government spending + exports - imports). But, consumption is not GDP. It's where output is directed. If the U.S. economy didn't produce the goods and services it consumed in any given period, either inventory investment has to fall or imports have to rise or some combination of both.

    Under normal circumstances, strong final demand augurs stronger output down the road. However, that thesis is called into question when (discounted) sales come at the expense of profits.

    Lastly, everyone's favorite bottom, Housing:

    In any interest-rate cycle, look at whatever sector is interest-rate and credit sensitive. Sub-prime lenders are going belly up. Signs of additional distress are showing up in larger home-loan companies. IndyMac Bancorp Inc. (NDE), the second- biggest independent mortgage lender, said its Q4 earnings would miss forecasts because of deteriorating credit quality in the home-loan market. Given the lax lending standards during the frothy part of the housing cycle, it's premature to conclude there will be no fallout from risky, exotic mortgages.

    These are just excerpts; the full article is definitely worth the read.

    The bottom line is there's a lot less to Q4 GDP data than meets the eye . . .

    Fourth-Quarter Economic Figures Don't Add Up
    Caroline Baum
    Bloomberg, Jan. 24 2007