Thursday, July 10, 2014

First Quarter GDP: The Don Nix of Economics

Does the name Don Nix ring a bell? Maybe not, but the composer, arranger, and musician wrote one of the most often covered blues/rock songs of all-time. Nix’s simple, yet catchy, “Going Down,” was first popularized by blues legend Freddie King in 1969 and has since been covered by a “Who’s Who” of guitar heroes from Jeff Beck-to-Warren Haynes-to-Joe Satriani. The song’s driving bass line and signature guitar riff, which lends itself to improvisational soloing, are guaranteed to put a smile on your face. Unfortunately, the opening line of the song, “Going down, down, down, down, down, down” also describes the estimates and reporting of US 1st quarter GDP. As a primer, the US government issues three GDP estimates over the three successive months following the end of each quarter. Prior to the government’s initial estimate on April 30th, the consensus was that the economy had grown at a seasonally-adjusted annual rate of 1.2%, well above the 0.10% indicated in the government’s initial report. Prior to the second estimate, market participants lowered their expectations to a contraction of 0.50% only to be disappointed when the government reported that the economy had contracted a full 1%.  The government’s final estimate landed with a thud last Wednesday as it reported a contraction of 2.9%, far worse than the consensus estimate of a 1.8% decline.  
While it has been fashionable to blame the 1st quarter’s poor economic performance on the weather, winter was already in the rearview mirror at the end of April when most believed the economy had grown, albeit modestly. Granted, factoring the impact of weather disturbances into economic forecasts is bound to widen the errors around those estimates. Yet the decline was far too severe to have been strictly weather-related. For perspective, consider the following.
  • The 1st quarter’s contraction was the worst economic performance since the first quarter of 2009, when the US economy remained mired in the Great Recession. It was also the 17th largest contraction in GDP since the government began keeping quarterly data in 1947, i.e. it’s in the bottom 10% of all quarterly GDP reports.

  • The Japanese economy contracted an annualized 6.9% in the 1st quarter of 2011 and 3% in the 2nd quarter that year in the wake of the earthquake and tsunami that devastated the nation in March of 2011. Bear in mind that the Japanese economy had contracted 4.1% in the 4th quarter of 2010 and was either in, or likely on its way into, recession when the disaster struck.
  • Snow coverage and temperatures across the continental United States were not materially more severe last winter than during the winter of 2009-2010. However, while the economy contracted 2.9% during the 1st quarter of this year, it grew 1.6% during the 1st quarter of 2010. While the winter of 2013-2014 appears to have had a greater impact on major metropolitan centers than that of 2009-2010, it certainly doesn’t account for the 4.5 percentage point difference in the respective 1st quarter growth rates.   

Almost by definition, it takes multiple culprits to create such a contraction, and indeed, weakness was present throughout the report. Most disconcerting may be the fact that consumer purchases grew a scant 1% on an annualized basis, the slowest pace of growth in five years, adding just 0.71 percentage points to growth. Surely weather delayed some purchases, especially those of durable goods such as autos, but given the rise in online spending over the last 15 years, blaming weakness in consumer spending entirely on the weather rings somewhat hollow. While the economy has been adding jobs, a significant portion of these jobs have been in low wage industries and income growth remains weak. As such, while weather played a role, weak income growth was likely the more significant factor restraining consumption. While weak consumer spending may be the most concerning aspect of the report, the real damage was done by a widening trade deficit and a lack of inventory accumulation. The widening trade deficit subtracted 1.53 percentage points from growth while the fact that inventories grew at less than half the pace of the 4th quarter subtracted another 1.70 percentage points.  

If this report doesn’t put some large nails in the coffin of the bad weather/economic acceleration argument we can’t imagine what will. Yes, severe weather negatively impacted 1st quarter GDP growth and we appear to be getting some weather-related payback this quarter. Yet as noted above, the weather was not dissimilar to that experienced across the continental United States in the first quarter of 2010, yet GDP growth was four and a half percentage points worse. Assuming weather explains the four and a half percentage point difference, which we don’t, we are left with growth of about 1.6% ex-weather. That itself would have been the worst growth rate since the 1st quarter of 2013. Simply put, the narrative of accelerating economic growth doesn’t fit the underlying data.