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Friday's GDP May Look Too Good to Be True

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I’m Jason Stipp for Morningstar. We get the government’s first read on first-quarter gross domestic product Friday, but there's a lot going on under the surface of this number. Here to help clarify and provide some context for Friday's number is Morningstar's Bob Johnson, our director of economic analysis. Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: We will get the first read on first quarter GDP on Friday. This is the first read. This number, whatever it turns out to be, is subject to change. Before we get into the details, why is this number subject to change? They don't have all the data yet, right?

Johnson: Right. They want to give everybody a general knowledge of where the economy is, and get it out as fast as they can. So that's why we always have a first read. But we don't have the actual numbers for imports/exports. That number is hard to collect because it comes through all the ports and it’s a very complicated set of reports. So they’re actually estimating what the March imports and exports are. And inventory is another one where they’re kind of just guessing for now, and then as we get further along in the process that gets revised out a little bit.

Stipp: Some of these factors can have a pretty big effect on the second or the third read. For example, in the fourth quarter it was originally negative 0.1%, but that got revised to 0.4% for the fourth quarter. So now for the first quarter a lot of economists are expecting a pretty big increase. What is the range of expectations, and what are you thinking we’ll see for the first-quarter GDP?

Johnson: I think almost all the estimates I've seen are over 3%. There is kind of a range of 3% to 3.5%, maybe 3.1% what I might characterize as an average. I actually think those numbers could be just a little high. I mean, I think the number is probably 2.5% to 3.0%, somewhere in that range.

Stipp: What’s driving that? That’s a pretty big improvement even at the lower end of that range from the 0.4% that we saw in the fourth quarter. What’s behind the uptick here?

Johnson: I think the biggest number in there is probably going to be consumption, and the consumption number is going to be probably a 2% contributor to that overall 3% growth rate. So almost all of it is coming out of consumption, and then the big swing is also due to some of the other things not being as bad as they were in the fourth quarter.

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Stipp: So consumption is curious, because you raised some yellow flags on consumption during the first quarter. Why does consumption look so much better in the first quarter if it seems that we’re seeing some softening here in recent times?

Johnson: Well, I don't want to get too wonkish here, but the economists, when they go through and do the GDP, they take three months versus three months, and then multiply by four. So we’re looking at October/November/December versus January/February/March. Well, the way they fell, October was a disaster, and then November and December were kind of OK. Then this year we had a very strong January and February that kind of blew away the last part of last year, and then March was a slow number. So you roll them all together, and the remarkable number in February kind of overwhelmed the data and the real negative number for October. You put them all together, you compare those three months to each other, and then multiply the number by four, you’re really getting at that big 3% number. So it's a little bit of a statistical mirage, if you will.

Stipp: So if we get 3% or something close, and it is driven primarily by consumers, should we basically not necessarily believe that since we’ve seen some weakening recently? The trend is that maybe there is softness in some consumer spending, and that number maybe should be a little bit lower than 3% if we were getting a real number right at this point in time.

Johnson: Well, you know what, my guess on that is we weren’t anywhere near at a 0.4% growth in the fourth quarter. I think we did a lot better than that in reality, and I think that the 3% is equally silly and the truth lies somewhere in the middle, probably around the 2% growth rate, the rule of 2s is that I’ve been talking for probably two years.

Stipp: So why has this GDP number--it's looking at the whole economy--why have we seen in the short term such volatility in like we have a down months at first on a first read, and then it goes up a little bit, but it’s still less than probably is true. And now we’re going to get a number that’s probably a little better than truth. Why so much volatility in such a broad-based number?

Johnson: Well, a lot of it is inventory-related and those numbers kind of go up and down and have a life of their own. And sometimes it has to do with prices and stocking and so forth. So that number has been a big part of the swings lately, and whether it’s even measured right is another question. Certainly government’s been the other big bugaboo lately that we have a really good month and a really bad month. It used to be you count on the government for being steady-Eddie and you had normal seasonal patterns, where maybe certain quarters were higher. But when you adjust it for seasonality that was one thing you didn’t even have to think about as an economist. And now it's like, wow, we’re probably down pretty close to 2% in the fourth quarter in terms of government, and there’s some controversy. But most people agree we will be at least back to zero in terms of government when we see the report on Friday.

Stipp: So government’s been bit of a wild card. It is still an unknown; there's some disagreement about how it will affect the first read on first-quarter GDP. What do you think that inventories--you said that can be another wild card recently--what do you think the inventories will come in for that first quarter?

Johnson: You're right, that’s been an absolutely huge swing factor, and what really killed the fourth quarter was the minus 1.6% swing in inventories. The contribution took 1.6% off the GDP number. This quarter, again, there was a report on Wednesday morning that concerned just a little, but the general feel is that inventories will be net, not a detractor or not a adder to GDP. So it will be a 1.6% swing from that negative to zero in the first quarter. So it will be a significant reason for the improvement.

Stipp: Another factor that we look at in GDP is the balance of trade, and this is one you said we don't have all the information. There are some estimates. What do you think though, from the information we have, what might we get on that trade portion of GDP?

Johnson: Well, we had something unusual in the fourth quarter, where we had growth in the economy, not a lot, but we had growth, and the import/export number actually was a positive to GDP. That usually doesn't happen this far into a recovery. It added maybe 0.4% or so to GDP in the fourth quarter. I think in the first quarter it’s likely to revert to its more normal trend, which will be just a small detractor from the number, not a lot, but small.

Stipp: So there are a few things, we will kind of want to look through the number on Friday to understand some of these underlying factors at work. The question though looking ahead is, if we start to see some softness or the consumer goes through a weak patch--and that is the biggest proportion of GDP--do you expect then second-quarter GDP is not going to look as good as this 3% number? It’s going to maybe get us back to closer to that 2%, which you think is the real underlying growth?

Johnson: I think we have been--and again, not the reality of the real world, but the GDP number has been on a yo-yo. If you look at employment, retail sales, or a lot of other factors, we’ve been at a relatively stable pace. But the GDP number has been on a yo-yo, and if we have a really good quarter, it’s almost followed always by a slower one, and that’s been pretty much cast in concrete here. I would expect maybe 2% growth in the second quarter. I was probably even a little bit more worried about that because I talked about the way the pattern in the months and the quarter fell. Well, we had a less optimal pattern for the second quarter, where we started out strong and ended weak. So now we’ve got to grow a lot just to get back to kind of zero, so to speak, in the second quarter. But falling gasoline prices, falling food prices, and just a general better overall environment and increased housing industry and housing prices, which continue to be on a tear, will probably be three factors that--you know what, the second quarter isn’t going to be a disaster. It’s not going to be another back to the 0.4%, I don't think. But I don't think it’s going to be a lot better than 2%.

Stipp: So possibly a lot closer to what you think the real underlying economic growth is. Bob, well, it’s some great context for Friday's number. Thanks for joining me today.

Johnson: Thank you.

Stipp: For Morningstar, I’m Jason Stipp. Thanks for watching.