The First Advance estimate for 3Q GDP released on 27th Oct 2022 showed US GDP rebounded back growing at a 2.6% annualized rate after having fallen 1.6% and 0.6% in Q1 and Q2 respectively. There are 3 key points to understand about the full US GDP picture so far in 2022.
- The US Consumer still remains incredibly resilient.
- Growth in the US economy is actually less stellar than headlines and initial estimates suggest
- PCE and Business Investment are gradually trending down. Once that takes speed, coupled with inventory reductions, weak growth in the rest of the world and a rapidly deteriorating housing market, headline GDP can fall faster than currently expected.
Lets run through this analysis in more detail.
- The US Consumer still remains incredibly resilient.
Many had expected the US consumer to wilt by now in the face of constant elevated inflation. Yes, there has been a slowdown in consumption. But simply not to the extent that Chair Powell would like to see.
Here’s a chart for simple comparison. Real PCE has grown at annualized rates of 1.3%, 2.0% and 1.4% in the 3 quarters of 2022. In the 4 quarters of 2008, annualized GDP growth rate q-o-q was -1.10%, +0.06%, -3.00% and -3.70%. I am not suggesting that we are in a 2008 type of global crisis scenario. Not even close. But even if you look at the last down turn in late 2018 and early 2019, Real PCE growth rates were closer to 1%. But remember that inflation was a lot benign then and the Fed could afford to reverse tightening policy and let the economy have some breathing space. With CPI at 8%, Real PCE at 1.5% is simply unacceptable to the Fed.
Unarguably, one of the key reasons for the strength of the US consumer has been the large fiscal support payments received during 2020 and 2021 and the resultant excess savings. A recent Fed paper estimated that US households accumulated about $2.3 trillion in 2020 and 2021 above and beyond what they would have saved if income and expenditure would have growth at pre-pandemic trend rates. i.e. truly excess savings. The same paper also suggests that US households still hold three fourths of these excess savings. While that might be up for debate, there is no argument against the fact that the consumer continues to spend, irrespective of the source being excess savings or incremental debt. This can also be evidenced in other data points – a simple example being used car prices which continue to stay relatively elevated.
2. While GDP growth has been carried through sufficiently by a robust (and so far healthy US consumer), part of that GDP growth in the last 12 months has been attributable to increasing inventories and a volatile net export component (especially contributing quite positively in the third quarter).
The last negative change (reduction) in private inventories was 3Q 2021. Even so, that was a smallish decline of US$49bn of inventories on seasonally adjusted annual rate basis. The next four quarters, change of private inventories on a similar annualized basis has been US$198bn, US$214bn, US$110bn and finally in the latest 3Q 2022 quarter US$62bn.
While most people are focused on first releases of economic data, subsequent revisions also usually have an interesting story to tell. Below is a chart comparing latest revised data on Change in Private Inventories versus previous estimates. In summary, inventory accumulation has been higher than initial estimates.
Lastly, while US GDP grew a robust 2.6% in Q3, a favourable move in net exports was a strong contributor to that headline growth number. Net exports tends to be fairly volatile. Add to that – a deteriorating global outlook and the significant challenges in Europe and the UK. In fact, final sales to domestic purchasers, which strips out the trade and inventories component, grew only 0.5% in Q3 – significantly below pre-pandemic trend levels. A more accurate representation of core domestic growth.
3. Housing has already cratered. But business investment has remained solid. If consumption does actually fall significantly over the next couple of quarters, the large negative impact to GDP growth from slowing or falling inventories coupled with a weak housing sector will make the headline GDP growth number significantly negative.
Housing is beaten down significantly. Housing transactions have absolutely cratered.
As mentioned in my earlier post on the US Housing Market, housing gets reflected in GDP in two ways. First, through residential fixed investment which includes the construction of new single family and multi-family homes and some other related activities. In 2021, Residential Fixed Investment contributed $1,086 billion to US GDP (4.7%). Second, through all spending on housing services which includes renter’s rents and utilities and home owners implied rent and utility payments. In 2021, this category contributed approx. $2.8 trillion to US GDP (12.2%). Together, housing as a sector, hence contributes about 17% to US GDP. A sizeable number ! Residential fixed investment has fallen at annualized rates of 2%, 18% and 26% in the three quarters of 2022.
Business investment, on the other hand, has continued to surprise on the upside. Fixed Investment in the categories of Equipment and Intellectual Property Products contribute approximately 10% to the US GDP calculation. Below chart shows annualized growth rates of these 2 key components of Fixed Investment over the past 3 quarters of 2022.
That resilience in business spending can also be evidenced in that Durable Goods Orders indicator which has been up six of the last 7 months. While it has continued to be positive, the growth is indeed much lower than 2021 and the period before.
Bottom line though, is that once consumption starts to roll over and businesses cut back capex, there can be a pronounced hit to GDP growth. That headline number can get exacerbated by falling inventories which mathematically deduct points from the GDP growth calculation.
Economists largely expect 0 to 1% GDP growth in 4th quarter. The current forecast of the Atlanta Fed GDP Now tracker projects 4.0% but that can be expected to come down with additional data releases. What matters most is what happens to expectations of 1H 2023 GDP.
I believe the current equity market environment is still one where bad news is good news since it gives a reason for a rate pause. But with prolonged passage of time this narrative will change and the headwinds to the economy become large enough that mere pauses in rate hiking don’t prove sufficient. I think 2022 has proven a lot of forecasters wrong, thanks to the US consumer. While that might have contributed to the inflation pain, it has also managed to keep employment high. 2023 might be a different story. Got to hang in there!
Disclaimer and Disclosure: Not meant to be investing advice ! Do your own research! I am long both equity and fixed income positions though overall bearishly positioned for the short term portfolio.