GDP Could Get Even Worse

by: William Trent, CFA

The market rallied on Friday on news that the economy was weaker than expected, with all of the convoluted logic about the fed pausing on rate hikes and blah-de-blah. Far be it from us to take away the punchbowl. Yet, as often is the case, actually reading through the data yielded some interesting insights.

Consider the below chart, which breaks the GDP number into its four main constituents: consumer (personal consumption), business (NYSE:PDI), trade (net exports) and government spending.

Contributions to GDP

The second quarter marked only the second time (though there were some close calls) that all four constituents had a positive impact. However, in one way that tidbit shows just how weak the economy has become. The last time we fired on all four cylinders, GDP grew at an annualized rate of more than 7 percent. This time it got us 2.5 percent.

The second thing we want to touch on is the maxim we keep hearing about how business will take over when the consumer tires out. Let’s face it: all of the other categories have, at least for one quarter, been a drag on GDP within the last four years. It seems reasonable to believe that the consumer may take a turn resting. As has been the case when other components failed to pull their share, isn’t it possible that total GDP could come in at a reasonable number - say 3 percent?

The problem here is one of magnitude. In the second quarter, total GDP was a little more than $13 trillion. In round numbers, $9 trillion of that was consumer, business and government put in a little more than $2 trillion each, and net exports took that “little over” back by being negative (they had a positive impact on GDP because they were slightly less negative than they were last quarter.)

So now let’s do the math, and assume that the average consumers spends 1 percent less than they did last year. That creates a $90 billion drag the others need to make up. But if we want the whole pie to grow 3 percent, that is $390 billion that needs to be added to GDP overall, plus the $90 billion that needs to be made up equals $480 billion. That would mean business and government each growing 10 percent, or one of them growing 20 percent. It just doesn’t seem all that likely.

There is one wild card, and that is net exports. If we made the assumption that consumers only bought less foreign goods, then the personal consumption would be neutral to GDP rather than a drag. But even in that optimistic (unless you are an importer) case business and government would have to grow faster than 8 percent each for the economy to grow 3 percent overall in the face of flat consumer spending.