Decluttering the GDP Data Clutter !

Image Courtesy: NBC News

Introduction: Q1 2022 GDP fell 1.4%. How bad were the numbers really?

The First Advance estimate for 1Q22 showed US GDP fell 1.4%. Generally, that is bad news. It adds yet another cat to those already amongst the pigeons. High inflation, rate hikes, etc.


However, a look below the hood shows the US consumer has been incredibly strong. PCE grew at a seasonally adjusted annual rate of 2.7%. Just to put things in context, the past 4 quarters (in 2021) PCE growth rates have been 11.4%, 12.0%, 2.0% and 2.5%.

Source: Trading Economics

Retail sales numbers have validated the strength of the US consumer as well.

Source: Trading Economics

The fall in GDP can significantly be attributed to the negative contribution from net exports. Exports fell 5.9% while imports increased 17.7% contributing a negative drag of 3.2 percentage points to GDP growth in 1Q 2022. Business investment, on the other hand, continued to be robust as non-residential fixed investment surged at a 9.2% annualized rate.

So all is good? Not really. Here is the catch.….

US GDP grew at a massive rate of 6.9% in the 4th quarter of 2021. Change in inventories contributed 5.3 percentage points to Q4 2021 GDP growth. This build-up of inventories continued in 1Q 2022, but at a decelerating rate. The change in the pace of the change of inventories contributed negatively to GDP growth in Q1 22. To be specific, the nominal level of change in private inventories was US$249bn in Q4 2021 and US$206bn in 1Q 2022. In simple words, there continues to be a build-up in wholesale and retail inventories. If consumer demand falters significantly, this pile up of inventories is sure to cause significant economic pain.

See below charts for wholesale and retail inventory build-up. A picture speaks a thousand words !

Source: Trading Economics
Source: FRED

Yet even though retail inventories have risen as businesses stock up in anticipation of sales demand, the retailers inventory-to-sales ratio of 1.13x is well below pre-pandemic levels of 1.4x.

Inventories are typically expected to rise when demand is weak. There is enough empirical macroeconomic evidence that suggests inventory adjustment appears to accentuate during economic downturns and subsequent recoveries.

At the start of a downturn, involuntary stock building occurs as demand falls faster than production can be adjusted. However, this is followed by a destocking phase, as companies seek to reduce inventory levels through production cuts, which depresses the economy even further during the downturn.

Understanding the contribution of inventories to GDP calculation can be confusing. It is not the total level of inventories or quarterly change in inventories that impacts GDP growth, but rather the change in the pace of the change that matters !

Investing can be a game of patience. The last 12 months have all been about the macroeconomic risks. Everything else simply did not matter. We seem to be inching close to the bottom though!

Happy Investing!

To know more about the Federal Reserve and US Monetary Policy, take our Fed Demystified course and watch the videos at the link below!

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Disclaimer and Disclosure: Not meant to be investing advice ! Do your own research!

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