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Bottom line Yesterday, the Commerce Department revised its first-quarter Gross Domestic Product (GDP) down sharply, from a modest gain of 0.1% in its flash report last month to an outright decline of (1.0%). This marks the second-worst quarterly performance for economic growth since the Great Recession officially ended 19 quarters ago in June 2009, surpassed only by the (1.3%) decline in the first quarter of 2011. In fact, yesterday’s revision was twice as bad as Bloomberg consensus expectations of a revised (0.5%) decline, and first-quarter growth now clearly pales in comparison to the fourth quarter’s GDP growth rate of 2.6% and the third-quarter’s relatively strong 4.1%.
While the headline revision looked miserable, the underlying details—such as trends in inventories, capex and net trade—actually were not nearly as bad, and they provide us with some encouragement that a sustainable economic bounce is underway. To that point, even the perma-bears will concede that the brutal winter weather negatively impacted economic growth in December 2013 and in this year’s first quarter. We should enjoy a powerful, weather-induced second-quarter rebound, taking the fear of a potential double-dip recession off the table. We’re officially at a 3.6% GDP estimate for the current quarter, and there are some economists who are forecasting 4- and 5-handles. The perma-bears, however, expect GDP growth to slip in this year’s second half back to sub-trend levels. We disagree, and believe that catalysts such as stronger employment, consumer spending and manufacturing activity will result in a sustainable economic recovery through the balance of 2014.
Here are the details surrounding the first-quarter’s GDP revision:
Consumer spending revised higher As we had expected, personal consumption expenditures, which account for 70% of GDP, rose by a stronger-than-expected 3.1% in the first quarter (versus a 3.0% gain in the initial report), boosted by the largest gain in services in 14 years. This contributed 2.1 percentage points to first-quarter growth, which was a tick higher than previously reported. Personal consumption had grown by 3.3% in the fourth quarter and 2.0% in the third quarter. After the weakest 3-month Christmas retail sales season since 2009, retail sales strengthened considerably during the March-April Easter season. So the U.S. consumer appears to be on firm footing.
Inventory restocking pace gutted This was the single biggest negative swing factor in the first-quarter’s downward GDP revision. Because of the difficult winter and concerns about softening end-market demand, businesses sharply reduced their elevated inventory levels during the first quarter of 2014, adding only $49 billion, down from an initial inventory restocking estimate of $87.4 billion. By comparison, businesses had added $111.7 billion and $115.7 billion in inventories in the fourth and third quarters, respectively. That represents a revised first-quarter inventory drag of 1.62 percentage points, nearly triple the Commerce Department’s initial estimate of a 0.57 percentage point reduction from GDP growth and the largest such drag since the fourth quarter of 2012. The silver lining, of course, is that if economic growth does, indeed, recover from here, we could see the advent of a new inventory restocking cycle commence in this year’s second half, which will boost GDP growth.
Trade deficit worsens Exports were less bad upon further review, falling by only (6.0%) instead of the initial estimate of a (7.6%) first-quarter decline, compared with a robust 9.5% increase in the fourth quarter to record levels. But imports actually rose by 0.7% in the first quarter versus an initially estimated (1.4%) first-quarter drop. Imports had risen by 1.5% in the fourth quarter. Taken together, net trade subtracted 0.95 percentage points from first-quarter GDP—the worst reading since the second quarter of 2010—compared with an initial 0.83 percentage-point subtraction from first-quarter GDP growth. But the good news here is that imports were revised positive, which implies continued economic strength among U.S. consumers. The trend in exports is largely beyond our control, driven by the economic strength of our trading partners and the relative swing of their currencies compared with the dollar.
Corporate capex structures hurt by winter weather Real business fixed investment declined by only (1.6%) in the first quarter, compared with an initial estimate of a (2.1%) first-quarter drop. Corporate capex had risen by 5.7% and 4.8%, respectively, in the fourth and third quarters. But looking at the key components, business structure investment—a very volatile category that includes factories and office buildings—was the single biggest negative, largely due to the difficult winter weather. Spending on this category was revised down sharply to a decline of 7.5% from an initial estimate of a modest 0.2% first-quarter increase, versus a 1.8% fourth-quarter decline and huge increases of 13.4% and 17.6% in the third quarter and second quarters, respectively. So better weather should help to restore more robust investment in business structures, which will help reverse the 0.20 percentage points subtracted from first-quarter GDP growth. Business equipment and software spending fell by 3.1%, which is an improvement over the initial estimate of a 5.5% first-quarter decline. That compared with a 10.9% fourth-quarter surge. Finally, intellectual property spending was revised up to a gain of 5.1%, versus an initial estimate of a more muted 1.5% first-quarter increase. That’s more in line with fourth- and third-quarter gains of 4.0% and 5.7%, respectively.
Housing still soft Because of the brutal winter, higher mortgage rates and prices, tighter bank-lending standards, reduced inventories, rising student-loan debt and impaired affordability because of the fiscal cliff tax hikes, housing fell for the second quarter in a row, but by a less-bad 5.0% versus an initial estimate of a 5.5% first-quarter drop. While that subtracted 0.2 percentage points from first-quarter GDP growth, it’s an improvement over the 7.9% decline in the fourth quarter. In sharp contrast, residential investment had risen by 10.3% in last year’s third quarter, 14.2% in the second quarter and 12.5% in the first quarter. We’re clearly disappointed in the sluggish pace of housing activity over the past six months and the lack of a strong bounce thus far this spring.
Government spending slightly worse Total government spending, which accounts for about 17% of total U.S. GDP, slipped by 0.8% in the first quarter, compared with an initial estimate of a 0.5% decline. That reduced GDP growth by 0.1 percentage points. Government spending had suffered a 5.2% decline in the fourth quarter.