Why 1Q GDP Was Not Nearly As Bad As It Looked

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
May 3, 2022

IN THIS ISSUE:

1. Was The Latest GDP Report Really That Bad?

2. The Good News In The Latest 1Q GDP Report

3. The Bad News In The Latest 1Q GDP Report

4. Consumer Confidence Index Remains Solid

Overview – Was The Latest GDP Report Really That Bad?

No. I’ll explain why below. Last week, the Commerce Department released its first of three estimates on 1Q Gross Domestic Product – the sum of all goods and services produced by the US economy – in the January-March quarter.

The number came in considerably lower than expected by most forecasters at an annualized loss of 1.4%, the first quarterly loss since 2020. To put that into perspective, the US economy just came off its strongest year of growth in decades in 2021 as we recovered from the COVID-19 recession.

The US economy soared at an annual rate of 6.9% in the 4Q and grew by 5.7% for all of last year. Both of those figures are the strongest since 1984. The point is, it was widely expected the economy would slow down considerably in the 1Q as the pandemic recovery was mostly behind us. Just not that much!

While the 1Q GDP print of -1.4% was a stunner, a closer look at the report reveals it was not nearly as bad as the headline number suggested. In fact, there was quite a lot of good news in the latest GDP report, which I will explain as we go along today. Let’s dive in.

The Good News In The Latest 1Q GDP Report

As noted above, last week’s initial report on 1Q GDP came in at a surprising -1.4% annual rate, down sharply from 6.9% in the 4Q of last year. According to the Commerce Department, the decrease in real GDP reflected decreases in private inventory investment, exports, federal government spending and state and local government spending – while imports, which are a subtraction in the calculation of GDP, increased. This was what the media largely reported.

Graph showing real GDP

Yet there was considerable good news in the latest GDP report that you probably didn’t hear about. Let’s start with consumer spending which accounts for two-thirds of GDP and business investment which makes up much of the rest. Buoyed by strong job growth, American households continued to spend amply in the first three months of this year, and US businesses invested heavily in new equipment, particularly in information technology.

Bottom line: Overall sales generated by the private sector increased at a healthy annual rate of 3.7% in the 1Q, which suggests a good rest of the year. What, you didn’t hear that? For reasons I don’t fully understand, the mainstream media largely ignored this good news.

More specifically, consumer spending increased at an annualized rate of 2.7%, and nonresidential private fixed investment in equipment by businesses rose at a rate of 15.3%. Obviously, both of those are solid numbers.

The question is: How could GDP have declined when consumers and businesses both spent more than they did in the previous quarter? Doesn’t make sense, does it?

To answer this question, you have to consider what GDP – the overall production of goods and services in the US – consists of and how it is measured. In the most recent quarter, three specific factors depressed the headline GDP growth figure considerably.

The Bad News In The Latest 1Q GDP Report

First, a good deal of the extra spending in the 1Q was on goods and services produced outside the US, which added to the trade deficit rather than GDP. Despite all the stories about supply-chain problems overseas and clogged ports at home, a lot of imported products – such as computers, clothes, semiconductors, etc. – still managed to make their way here in the 1Q.

Imports of these goods rose by more than 20% annualized, while the value of goods America exported fell by nearly 10%. If you add services, such as tourism and financial services, total imports rose at a rate of 17.7%, and total exports fell at a rate of 5.9%. These developments alone knocked the GDP growth rate down by 3.2 percentage points, according to the Commerce Department.

Another negative factor was a rundown in inventories, goods that businesses keep on hand for restocking purposes. Although changes in inventories don’t generate any sales at the time they are made, government statisticians count them in GDP on the grounds that they are part of what the economy produces.

In the 4Q of last year, many businesses built up their inventories to prepare for the holiday season and avoid supply chain snafus; this helped boost the headline GDP growth rate to a bumper 6.9%. In the 1Q, this process worked in reverse, reducing the headline figure significantly. A lot of businesses, particularly those in the auto industry, ran down their inventories significantly. According to the Commerce Department, this factor reduced the growth rate of GDP by close to one percentage point.

A third factor which reduced GDP growth in the 1Q was a drop in government spending, particularly at the federal level, where the decline was close to 6% at an annualized rate. Some of this drop can probably be accounted for by the running down of the $1.9-trillion American Rescue Plan, which Congress passed in March 2021. The decline in government spending reduced the growth rate of GDP by another half a percentage point, the Commerce Department calculated.

If you add these three volatile factors affecting GDP together, they reduced the headline growth figure by roughly 4.5 percentage points, which explains why it came in negative even though underlying spending by households and businesses was solid.

It should also be noted that in the first three months of the year employers created nearly 1.7 million jobs, and the unemployment rate fell from 3.9% to 3.6%. In other words, the headline GDP figure was misleading. “Cutting through the noise [in the report], the U.S. economy appeared generally robust,” Greg Daco, the chief economist at consulting firm EY-Parthenon, noted. Likewise, the economics team at Goldman Sachs pointed to the GDP report’s “much firmer” internals such as consumer and business spending.

In the coming quarters, the inventory restocking and the expected fall in military spending are likely to reverse themselves – which should be positive for GDP growth. What will happen to the third negative factor – the trade balance – is more difficult to say.

Given the COVID lockdowns in China and the economic fallout from the war in Ukraine, there is a lot of uncertainty about the prospects for imports and exports, which reflect international trends. If the global economy slows down sharply this year, which seems increasingly likely, that will certainly impact growth in the US. How much we’ll have to see.

The big economic question is what will happen to spending by households and businesses – the bedrock of the economy – as the Federal Reserve moves to raise interest rates, last year’s stimulus continues to diminish and high inflation rates continue to eat into purchasing power. Already, there are signs that some types of interest-sensitive spending are being affected. For example, with mortgage rates rising, existing-home sales fell in February and March.

Consumer Confidence Index Remains Solid

The US Conference Board reported last Tuesday that its Consumer Confidence Index remains in solid territory despite declining modestly in the last few months. The Consumer Confidence Index declined slightly to 107.3 in April from 107.6 in March. It’s a little hard to see the latest decline in the chart below, but it was there.

Graph showing U.S. Consumer confidence index still strong

Still, this is nothing to be concerned about in my opinion. The Index remains solidly above 100, which is a sign the economy is continuing to expand. The Consumer “Expectations Index,” which shows where consumers think the economy is headed, actually increased slightly in April to 77.2 from 76.7 in March (not shown). While 77.2 is not a particularly strong reading, at least it was up from March – meaning consumers are not in a panic about the economy.

While consumers continue to express concerns about rising inflation and the war in Ukraine, consumer spending actually increased modestly in April (also not shown). Consumers continue to spend freely, and businesses are still investing, despite the sharp drop in headline GDP growth.

Consumers, most of whom cut back spending and saved considerable money during the pandemic, are clearly ready to spend some of those savings and are ready to get out and travel. The national average price for a hotel room is up 14% from the pandemic low.

The bottom line is that while the advance 1Q GDP was weaker than expected at -1.4% annualized, there was considerable positive data in last week’s report. Specifically, consumer spending and business investment – two of the biggest drivers of the economy – were solid.

Again, I don’t know why the media chose to largely ignore this good news in its reporting, but I thought it is important for my clients and readers to know the GDP report was not nearly as bad as it looked. And there are reasons to believe the economy will improve some in the upcoming quarters.

All this suggests we are not facing an imminent recession as many in the media would have us believe. Yes, we are overdue for a recession but I don’t see one on the near-term horizon. Likewise, I don’t think we’re in a bear market in stocks but rather a correction which I expect to end fairly soon.

I’ll leave it there for today.

All the best,

Gary D. Halbert

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