The First Advance estimate for 4Q released on 26th Jan 2023 showed US GDP grew at a healthy rate of 2.9% annualized. Even Q3 GDP had been revised upwards to a final growth rate of 3.2% compared to the first advance estimate of 2.6%. Below are the key points to note about this report.
- The US Consumer still remained incredibly resilient in Q4 but recent monthly data have evidenced a sharper reduction in consumption towards the end of 4Q 2022 and into 2023. The January Retail Sales report to be released on 15th Feb becomes incredibly important in this backdrop.
- A substantial acceleration in the change in private inventories had been a major contributor to the substantial GDP growth prints of 2.7% and 7.0% in Q3 2021 and Q4 2021. In similar fashion, change in private inventories contributed +1.46% to the 2.9% GDP growth rate in 4Q 2022. Resilient consumption in 1H 2022 meant those 2021 inventories were put to good use. If consumption slows significantly in 2023, any new build-up of inventories will put more downward pressure on prices and consequently corporate profits.
- Non-Residential / Business Investment had been fairly resilient the past 2 years. However it was substantially soft in Q4 2022. When viewed together with falling industrial production and capacity utilization, it becomes a greater cause of concern from a recession perspective. However, similar to personal consumption expenditure, these levels are still far from the levels of the past recessionary episodes.
Let’s analyze each of the above 3 points in a little more detail…
1. The US Consumer still remains incredibly resilient.
Many had expected the US consumer to wilt by the end of 2022 in the face of constant elevated inflation. Yes, there has been an overall slowdown in consumption. But it, unexpectedly, remained resilient well into 2H 2022.
2022 real PCE compared to previous cyclical downturns of 2008 and 2018…
But recent Retail Sales data (November and December) presents a sharper downdrift which might be more indicative of things to come in 2023.
This is also evidenced in the monthly PCE data, especially readings for November and December.
Undoubtedly, consumption has been slowing on a month on month basis. Going back to the first graph in this Section though, while evidently slowing, it is still substantially higher than previous recessionary episodes.
2. A substantial acceleration in the change in private inventories had been a major contributor to the robust GDP growth prints of 2.7% and 7.0% in Q3 2021 and Q4 2021. In similar fashion, change in private inventories contributed +1.46% to the 2.9% GDP growth rate in 4Q 2022. Resilient consumption in 1H 2022 meant those inventories accumulated in 2021 were put to good use. If consumption slows significantly in 2021, any new build-up of inventories will put more downward pressure on prices and consequently corporate profits.
Headline GDP growth was stellar especially through the 2nd half of 2021. A large part of that growth was attributable to rising inventories as companies over-ordered, over-produced and over-stocked driven by the late 2020 and early 2021 experience of booming sales and shortage of goods (and manpower) to satisfy consumer demand. Some of the inventories were taken down as consumption remained resilient in the first none months of 2022. However, a significant portion of the headline growth number for 4Q 2022 is also attributable to change in private inventories. The question is – will consumption remain resilient enough to take those inventory levels down?
The below graph shows the contribution of change in private inventories to Gross Private Domestic Investment (and consequently to headline GDP growth rate) over the last 6 quarters. Just for clarity – Gross Private Domestic Investment in the GDP calculation includes Fixed Investment (i.e. Business investment, Software and IP investment, Residential Investment) and Change in Private Inventories. The yellow bars (CIPI) adjacent to the orange bars (GPDI) shows visually that a large part of the GDPI growth was attributable to increase in the pace of change of private inventories and less attributable to Fixed Investment. The grey bars represent Fixed Investment contribution to GDP growth which has been relatively soft – obscured by the robust headline numbers. Also, the drag in GDPI is mostly attributable to the significant slowdown in the US Residential Housing sector.
Q4 2022 is even more stark in this context…
3. Non-Residential / Business Investment had been fairly resilient the past 2 years. However it was substantially soft in Q4 2022. When viewed together with falling industrial production and capacity utilization, it becomes a greater cause of concern from a recession perspective.
Before we dive deeper into this point, it is worthwhile to understand once again what do we mean by Gross Private Domestic Investment (“GPDI”) and Non-Residential Fixed Investment. GPDI is a key component of GDP. Non Residential Fixed Investment is a key component of GPDI and includes expenditures by private firms on tools, machinery, factories, etc. It is key to note that Commercial Real Estate spend also forms part of this Non Residential Investment category. Historically Private Non Residential Fixed Investment amounts to approximately 13-14% of US GDP.
The first point to note is that Non Residential Investment was fairly strong in late 2020 and 2021 as we came out of the pandemic. However, the pace of this growth in Business Investment has started slowing in recent quarters. Graph below.
Alongside this reduction in capital investments, the slowdown in the manufacturing sector can also be seen in recent releases of industrial production and capacity utilisation.
An interesting point to note is that industrial production and capacity utilization are coincident indicators at best or can even be categorized as lagging indicators – which can potentially mean that a recession has already begun. However, in reality, it is too early to state that a recession has already begun because other measures of recession (eg. jobs) are still robust.
And typically, business investment tend to fall a lot more during recession periods than the current levels.