Wed, 26 Feb 2014
The government's second read on fourth-quarter GDP, due Friday, will probably dip from the initial 3.2% reported growth rate--but don't hit the panic button, says Morningstar's Bob Johnson.
Jason Stipp: I'm Jason Stipp for Morningstar.
The government will release its second read on fourth-quarter GDP Friday. The first read showed 3.2% GDP growth; the second read may not look so good.
Here to explain why is Morningstar's Bob Johnson, our director of economic analysis.
Thanks for being here, Bob.
Bob Johnson: Great to be here today.
Stipp: Let's start first of all by talking about why GDP is an important metric to watch.
Johnson: It is the broadest measure of economic activity. It rolls a bunch of different statistics together that are reported separately, puts them in one coherent package, and it inflation-adjusts those numbers. So it's the single easiest number to grab to determine the strength of the economy.
Stipp: A lot of companies will benchmark against GDP growth, and it's estimated by a lot of economists, so you get a lot of expectations baked into GDP. It's theoretically useful, theoretically comprehensive, but there are also some problems with the measurement. The first has to do with inventories being a part of it, and those are volatile.
Johnson: Yes. In GDP, the P stands for Production. We don't measure production in dollars directly; we count how much is actually sold at stores, and then we know how much is left in inventories, and the balance must have been production. So, the inventory number becomes a critical part of the analysis, and that number is really volatile, because you have to adjust it for prices in two different ways: for inventory profits and the general level of rising prices. So that really complicates the number. And then it's physically dependent on people going out and counting and measuring that inventory. It's a very volatile number, and [even though higher inventories boost GDP], it's certainly not a good thing if inventories are rising because [factories] may then cut back on production in later months.
So, it's important to keep an eye on, but you've got to keep in mind this is a very volatile number, too, that you can't hang your hat on it.
Stipp: Exports is another factor that can swing the GDP number, but not everything we export corresponds to a lot of economic activity here in the U.S.
Johnson: That's right. A lot of weird things happen: Gold shipments go in and out, and that number can move around a lot in a given month, and that really doesn't do much for the economy. We've done more oil- and gas-related exports recently, and that's good for the economy and corporate profits, but it doesn't move employment around a lot. Even agriculture, the same thing--it doesn't really change the [fundamental economic] numbers around a lot, but it makes the export component of GDP look huge. And it was huge in the last quarterly estimate.
Stipp: The other thing to keep in mind about GDP is that it's not one and done. You're going to get a first read, a second read, and a third read on GDP. Why do those revisions have to happen?
Johnson: They want to get the numbers out on a timely basis, so people can react and plan their businesses accordingly. But nevertheless, the first read, which usually comes about one month after the end of the quarter, includes a lot of categories that are out-and-out estimated for the last month of the quarter. Many of the construction numbers, they don't know what the number is; they just have to go on a trend line. Exports are the same way. So in the latest report, they had to go off November data and just take a guess at what they thought December was going to be, and all they can do there is really take a trend line.
The second reason we have revisions is that they revise some of the underlying data. For example, this time around retail sales were revised substantially downward for November and December. So those really had to go in and be adjusted as well.
Stipp: We're getting the second read on fourth-quarter GDP on Friday. The first read showed 3.2% growth; we're expecting the second read to be lower. What accounts for that revision lower in some of these changes that they're making for the second read?
Johnson: There are a number of factors. Number one was exports are going to be lower than we thought they were going to be.
Inventory growth was a little less than we thought it would be.
And probably one of the bigger ones is residential construction spending was less than they originally estimated.
So you roll all those together, and you're at a much lower number than we would have been thinking.
Stipp: What are the expectations for the second read?
Johnson: We've been coming down--and I've been talking about this theme in my column every week for some time. I'm thinking [fourth-quarter GDP] could [be revised down to] 2% to 2.5%, with the more likely [number] being on the low end of that range, at 2% to 2.2%.
Consensus has come down from 3% a couple weeks ago to about 2.4% currently, which still feels a little high to me, but the government can go through and readjust other categories that I can't see, so there are no guarantees. I think 2% to 2.5% may bracket the range pretty well.
Stipp: Just for kicks, let's add one more level of complexity to GDP. There are different ways to look at the GDP growth rate. The number that we're going to get on Friday is looking quarter-to-quarter, it's seasonally adjusted, and you are getting that quarter-to-quarter growth rate annualized. That's one way to look at it; there are other ways. So how might the number look if you're looking year-over-year, for instance?
Johnson: The original quarter-over-quarter data showed we grew 0.8%, and we multiply that by four to get to 3.2%. We're annualizing small numbers to get to that. I'm not a fan of that number at all, but it is very current, and people like it, and if the seasonal adjustment factors were 100% accurate, it wouldn't be a bad way of looking at things.
The other way to look at it is fourth-quarter over fourth-quarter, and there the growth was 2.7%. So a little bit less. But that [2013 data point] was helped by Hurricane Sandy, which happened [in 2012], and that depressed the prior-period's fourth quarter. So that  number looks a little inflated.
Probably the more comprehensive but just a little less timely measure is to look at it for the full year, taking the four quarters averaged together, and there the growth was only 1.9%, which actually seems to be about where the economy really was, in my opinion.
Stipp: If we were going to forecast these three different metrics, you are expecting 2% to 2.5% for the quarter-to-quarter annualized [revised] fourth-quarter GDP growth. What would be the expected metric if you're looking quarter-over-quarter? So 2013 versus 2012.
Johnson: I said 2.7% [was the first-read] number on that basis. Now that number comes down to something like 2.5%. And if you look at the full-year over the full-year data [2013 versus 2012], I have to go one more decimal place to prove my point: from 1.9% to 1.85%. So very little reduction, which points to the notion that maybe that's the metric I should be using, and not these wild swings that we're seeing because of seasonal adjustments and short-term inventory adjustments, which are driving the [shorter-term] numbers crazy.
Stipp: These other ways to look at the data are suggesting around 2% growth, and we might actually see a revision that's pulling us a lot closer to 2% growth [for fourth-quarter GDP]. Would you say, then, even if we see this being reduction, it's probably not a reason to panic, provided it's in that range?
Johnson: Absolutely. I think that's so important. The headline numbers will be "Growth Reduced From 3.2% to 2.2%," "Growth Rate Now Half of What It Was in the Third Quarter," which was 4.1%... They'll make a story around that type of thing.
But in reality, we've got an economy that's been plugging along at 2% to 2.5%, and I continue to believe that's what it will do in the future as well.
Stipp: Bob, fantastic insights on the GDP report. Thanks for setting us up for that Friday revision.
Johnson: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.