Crossing the Ripping Point: Breaking Down GDP Components
The title is a bit of a play on Gladwell's "Tipping Point" and the historical "crossing the Rubicon", hopefully suggesting the crossing of a potentially decisive barrier or cusp point. Which, as we dig into the structural changes in the most recent GDP, seems like a reasonable but slightly scary, and growing, possibility. Before we dig into that though let's set the table by looking at what the consensus appears to be and see if we can fix some of the conceptual mis-understandings about business cycles built into much of the discussions. Here's a column from Fortune online that perfectly captures much of the thinking that we see as well as an online survey.
Dude, Where's My Recession? Out: Recession. In: Expansion. That's my quick take on today's first-quarter gross domestic product number, which showed that the economy grew 0.6 percent in the first quarter. Now that's not a robust number by any means, but it's not so bad given all the worry out there that the economy is headed off a cliff. Before you declare a recession, as many economic pundits have, shouldn't the economy, well, actually recess a bit—if only for a quarter? As a movie buff, I keep looking for the right cinematic analogy for the American economy. Try this one: It's like the Terminator. Not the Schwarzenegger one—the other one, the Terminator from the second film. You could empty a shotgun—or in this case, an imploding housing market, credit crunch, and high oil prices—into that morphing metal dude, and before you know it, the thing's all healed and chasing you again.
When asked where the economy would be in six months 30% though it'd be better, 50% thought worse and 20% the same. IOHO the folks voting thumbs down have got it right. The mis-conceptions, about which we've waved our arms a bunch, seem to be largely about the nature of the cycle and where we're at in it. Just to refresh your memories a bit recall that what comes 'round goes 'round. As consumer demand drops so does business output which then leads to declines in hiring and capex. Which then further depresses spending and demand.
When you look at the cycle over time you get a sine-curve that moves up and down around a trend, with the exact timepaths dependent on circumstances and history. Since we're very early days in this cycle you wouldn't expect to see serious downturns in spending or hiring yet. But the answer to "where's my recession" is that it's coming and, when you break apart GDP it is, for the first time, very clearly visible.
If we remember where we're actually at this has been a weak recovery, and a very poor generator of either jobs or real wage increases, which began slowing down way back in '06 without achieving organic growth. We missed a major downturn in consumption in '01 and beyond because spending was held up by the Housing ATM but that's long since becoming history. So one would normally expect a slowdown and at least a mild recession. But the housing boom was floated on a vast pool of funny money and perverse structured debt. When housing began to crater it took out the mortgage related instruments but then metastasized into a contagion that almost over-whelmed the entire set of worldwide credit markets and could have led to a severe downturn indeed. As we said back in March we've fixed the mechanisms but still have to face the unwinding of terrible debts and the re-pricing of risk. Meanwhile the slowmotion slowdown is beginning to tip over. On top of which inflation and energy costs are, in effect, a very serious tax on consumer spending that'll further depress it.
Much of which you can begin to see in the further discussion of GDP component charts below. In some ways we'd like to argue that this might be some of the more important economic charts you look at. What we will argue is that after looking at them your decision as to whether or not we're beginning to cross the "Ripping Point" will unavoidably be critical. One way or another you'll have to decide whether the sanguine consensus is right. Or these and similar views (Summers, Feldstein, Krugman, Roubini, G-S, Merrill, Buffett, ....) You have to read on down to get our bottomline conclusion of course :) !
BUT....if our take on where we're at and what's ahead is accurate the current sanguine views are very mis-placed indeed. We'll have to see of course. But think about what this all means for earnings, outlooks, valuations and the market as well.
YoY total real GDP increased about $280B, or ~ 2.5%, which on the surface wouldn't appear to be too bad (as we mentioned yesterday). The real question is what about the underlying components ? In other words what made up that change ? We like to look at the YoY changes by component and cumulatively to look at aggregate changes (the approach is explained in more detail in the prior posts on GDP Components in the Economic Data archive). On that basis the news is a lot less benign.
Component Changes
If we start by look at the YOY absolute and % change in each of the major components we end up with the accompanying chart. Take a good look at Consumption - Durable and Non-durable consumption, the heart of consumer spending in a lot of ways, took big....big hits. The only component that held up was Services. Meanwhile Capex actually declined relative to the prior quarter - a big deal harbinger indeed and RI continued to be a horrendous drag. Despite rumors Inventory build was only slightly positive - an improvement over a drag of course. The saving grace was Net Exports (Imports-Exports). In other words the only thing that saved the Economy from going into the tank badly in Q1 was a weak dollar along with gov't spending. This is born out in the second sub-chart which doesn't show YOY% changes. It shows the % contribution to the total GDP change - in other words how much of the $280B delta was accounted for by that component %-wise. The big four were Services, Capex, Net Exports and Gov. But what was the overall pattern compared to prior quarters.
Aggregate Component Contributions
In this combo chart we answer that question by looking at the running total of contributions. Given the way the chart is built you can how each component contributes to the total change AND compare it to the previous four quarters by total and %. Take a close look at Consumption. This quarter it's about $147B compared to last year's number of $282B - wow, ouch. Tell me again that there's no problem with the driving engine of the economy or we've seen the worst of things. Then look at the relative contribution of the Investment components. RI has been in the tank for along time but business Capex spending is beginning to tank as well and Inventory made a negligible contribution. Even with a steller trade performance we still show a steady decline.
We'd strongly suggest paying particularly close attention to the aggregate % contribution as indicators of how the cycle is working out. Q1/Q2 last year Consumption was the driving engine and Capex added to it with the major drag coming from RI. Then Consumption dropped down significantly in Q3/Q4 though Capex was still a significant positive contributor. This is exactly what on should expect give the nature of the business cycle. NOW Capex's contribution is turning down. These patterns look to be accelerating downward, at least from these charts.
Bottomline my friends is that the economy is beginning to tank and it's showing up just how, when and why you'd expect it when you understand the nature of the Business Cycle. We also means that we're really and truly at X marks the spot in terms of timing and outlook as well !