Q4 Data Doesn’t Add Up

Bloomberg’s Caroline Baum looks askance at some of the recent economic data, and finds it wanting: 

"The new year started with some old data that suggested the five-year U.S. economic expansion wasn’t ready for the retirement home just yet. Holiday sales were decent, only because of deep discounting on the part of retailers. Weekly jobless claims fell to their lowest level in almost a year in mid-January. Manufacturing output rose in December for the first time in four months, but it wasn’t enough to prevent a quarterly decline. Even housing, the economy’s weakest link, proved that things don’t go in one direction forever. The end-of-year bounce in sales and starts was somewhat suspect in the face of unusually warm winter weather."

As the new economic data has been released, the wizards of Wall Street ratcheted up their Q4 GDP forecasts. Consensus started near 2%, bounced up to 2.5%, and is now somewhere near 3%. Does the data actually justify this increase?

Baum says there are good reasons to be skeptical about fourth-quarter growth:

Retail Sales

• Consumer spending in Q4 (gains estimated at 4%) was more of a price than a volume effect, achieved through huge discounts.

• Nominal sales slowed. And nominal sales are the most correlated data series to corporate profitability.

• Consumer goods prices plummeted in Q4, as a result of massive markdowns. Excluding food and energy, retail prices they fell 2.8 percent in Q4 — the biggest decline in 3 years.

In other words, Retailers bought sales at the expense of profits. Then there is the suspect GDP data:

GDP: "Q4 2006 output measures don’t support 3% real GDP forecasts. Goods, Services and Structures suggest nominal output in Q4. Manufacturers’ shipments and inventories declined 4.5%, Construction Spending fell 3%, while Services rose 6%. Imports didn’t rise in the fourth quarter, and inventories rose at a slower rate than in the third quarter.

GDP is often measured from the expenditure side (consumption + investment + government spending + exports – imports). But, "consumption is not GDP. It’s where output is directed. If the U.S. economy didn’t produce the goods and services it consumed in any given period, either inventory investment has to fall or imports have to rise or some combination of both.”

Under normal circumstances, strong final demand augurs stronger output down the road. However, that thesis is called into question when (discounted) sales come at the expense of profits.

Lastly, everyone’s favorite bottom, Housing: 

 "In any interest-rate cycle, look at whatever sector is interest-rate and credit sensitive.” Sub-prime lenders are going belly up. Signs of additional distress are showing up in larger home-loan companies. IndyMac Bancorp Inc., the second- biggest independent mortgage lender, said its Q4 earnings would miss forecasts because of deteriorating credit quality in the home-loan market. Given the lax lending standards during the frothy part of the housing cycle, it’s premature to conclude there will be no fallout from risky, exotic mortgages.

These are just excerpts; The full article is definitely worth the read.

The bottom line is there’s a lot less to Q4 GDP data than meets the eye . . .


Fourth-Quarter Economic Figures Don’t Add Up
Caroline Baum
Bloomberg, Jan. 24 2007

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What's been said:

Discussions found on the web:
  1. Josh commented on Jan 24

    In the latest Fed minutes, there was mention that figures used for auto production or truck production in Q3 ended up overstating it and it would take a few quarters of understating GDP to make up for that. Meanwhile Q4 auto production was worse than Q3. I’m expecting a surprise to the downside in GDP.

  2. Philippe commented on Jan 24

    The OECD composite leading indicators is a reliable gauge of economic trends to come and it does not portray large economic upside either for Europe or the US where the medium trend is down for both.

    “The CLI for the OECD area increased by 0.2 point in November to 109.5 from 109.3 in October, but its six-month rate of change shows a downward trend since March 2006.

    The CLI for the United States rose by 0.2 point in November from a revised 106.4 in October. The revision is mainly due to a major benchmark revision in the US of its industrial production index. The six-month rate of change for the US shows a downward trend since March 2006. The Eurozone’s CLI increased by 0.2 point in November, but its six-month rate of change fell for the sixth consecutive month.”

    The benchmark revision of the US industrial production index is in contracditon with the latest US manufacturer’s survey which was less than upbeat.
    Since two months be it Europe or in US all public statistics are coming out of the press with the title “surprisingly” or unexpected.
    Let them finish with the long term interest rates pent up and the quicker the better.

  3. Fred commented on Jan 24

    ECRI’s leading economic models show a modest POSITIVE slope in growth.

    Barry…how does this play in your mind?

    The FIG shows a healthy decline. I’m curious why you don’t mention this work.


    BR: In the right hand column is a Google search box for the Big Picture. Type in “ECRI” — it generates 4 pages of mentions by me of them.

    This Google thingie is gonna be big one day — if people ever learned how to use it . . .

  4. B. Sneath commented on Jan 24

    Somebody help me out here. I look at the data, and conclude the exact opposite of both Ms. Baum and BR.

    Services rose 6% (economy’s largest sector)
    Imports did not rise (no take away from GDP)
    Should mention exports rose significantly (adds to GDP)
    The 4% sales increase was higher volumes and lower prices. This means inventory liquidation(mentioned) and future mfg or import demand.

    What do lower profit margins have to do with any of this – other than to spur higher demand?

  5. S commented on Jan 24

    Anyone that wants to purge breakfast need only read the CTX press release.

  6. GRL commented on Jan 24

    Funny you mention Indymac. I own quite a lot of Indymac. It was recommended by a newsletter a few years ago (which still recommends it, BTW). I have no complaints.

    In the book “The Future for Investors,” Jeremy Siegel points out that the best performing stocks over the long run tend to be those that pay a large share of their earnings in dividends and that have a “perpetual cloud” hanging over them that keeps the stock price low. Siegel cites the classic example of Altria, with all theor legal troubles, which returned something like 14% per annum over the last 50 years.

    It seems to me that Indymac fits the bill perfectly in the current environment. It has a trailing PE of about 8 (historical average 10), a PEG of .64, and, at current prices, a 5% yield. The company seems to be well managed.

    At the same time, Indymac is at the epicenter of the housing bubble scare becuase it specializes in Alt-A, interest only and other disfavored loan types for single family homes. If that’s not a cloud in today’s environment, I don’t know what is.

    Indymac warned last week, which knocked the stock down about 5 points (though it had already started trending down from recent highs before then). The conference call is tomorrow morning, and my guess is that’s worth another 1-2 points off the share price as more bad news/doom and gloom comes out over the course of the call (though today’s pop back up to 40 suggests otherwise . . .).

    All my friends think I’m crazy, and people need to do their own due diligence, but I think right now is a great time to buy Indymac.

  7. super-anon commented on Jan 24

    The 4% sales increase was higher volumes and lower prices…

    What do lower profit margins have to do with any of this – other than to spur higher demand?

    Here’s the problem as I understand it – it’s not such a problem if prices and profits (and ultimately revenues and wages) are stagnant/falling so long as production and demand are staying high. This is roughly equivalent to saying real GDP is healthy but diverging from nominal GDP (correct me if I’m wrong). Something like this seems to be going on now. Again, this wouldn’t be such a problem if it weren’t for one thing – debt.

    Debt tends to increase in burden in this type of scenario.

    What’s worse is that there’s a great deal of historical precedent for asset inflation ending in this manner (which we’ve had a lot of recently) – profits and wages don’t keep up with debt servicing costs, despite the fact that everything else is going fine, due to declining asset prices.

    So then the rising debt burdens threaten to choke off the system. Then everything becomes not so fine.

  8. Sponge Todd Square Pants commented on Jan 24

    Coast Bank in Bradenton Fla..(CFHI) is taking it on the chin. Shady RE loans .

  9. js commented on Jan 24

    The article is a less than coherent collection of facts and commentary thrown together. All I could glean was:
    1) Prices fell, Volumes rose. So what? Asia has been selling us cut rate goods for so long now. The falling prices of LCD Tvs is yet to hit the earnings growth of the S&P500. Keep waiting.
    2) Ignores the services side of the equation – as all these economists living in the 60s do over and over. Keep talking about the goods sector only.

  10. B. Sneath commented on Jan 24

    Fortunately corporate balance sheets, employment levels and real wages are strong … at the moment.

    In addition to the housing bubble/MEW effects, I think we are also beginning to see a long-term, demographic-driven trend towards lower personal consumption expenditures as boomers retire and cut back on discretionary goods and services. (Ed Yardeni was right, just 15 years early in his prognostication)

    I’m speculating that exports and import substitution will be needed to take up the slack. A lower dollar coupled with a global economic expansion. Lower global interest rates as Europe and emerging markets stimulate domestic demand.

  11. Estragon commented on Jan 24

    B. Sneath
    I think you’re right about increasing exports. As margins shrink on domestic sales, business should increasingly look to foreign markets for profit growth. Import substitution may be a darker view though, if it’s brought about through trade measures.

    It’s also worth noting that the demographic issue in the US is comparitively benign and further in the future than in several other large economies. Japan and parts of EU come to mind. Dependency ratios are set to rise rapidly in those areas, which almost certainly means these economies will not have enough workers to maintain current output levels. To a large extent, Japan can rely on other east asian economies, and the EU countries can rely on less demographically challenged EU countries to supply domestic demand. Still, there should be a substantial opportunity for US business in filling the gap.

  12. B. Sneath commented on Jan 24

    “Import substitution may be a darker view though, if it’s brought about through trade measures”

    Without a doubt! I am referring to the fact that, if the dollar drops in value, I might consider drinking more Budweiser because of the high cost of Heineken (hasn’t happened yet btw)

  13. john racer commented on Jan 24

    barry at what point do you come to the conclusion that all of the data that you find to bolster your bear case is pretty much useless for actually making money in the market? you have stayed bearish through one of the strongest rallies in years and now are at the point that even if we get a correction you probably will be buying much higher than where you were first bearish at.

    many have tried to time the market through the use of fundamental data but it is mostly a losing game. you end up with analysis paralysis. the market is an emotional animal and you often have to do what your emotions and your mind tell you not to do.

    i will admit that in writing this i am somewhat peeved because reading your bearish drumbeat this past year in part has keep me on the sidelines through this ramp.



    You are using a straw man — We never use fundamental data or macro economic data to SHORT TERM time the market, and quite frankly, we don’t know of anyone else who does either.

    The Top-down macro work is helpful for looking out 6-12 months; It gives you color as to where the next shift might occur. But using econ data to ST market time? WHo the hell does that?

    If you want to trade more frequently, and look at the very short temr (and the vast majoprity of people who do that lose money) than I suggest getting a different data set than Macro economics.

    Any short term positioningwe do is based on quant data, trend, technicals, and sector ranking. We especially like to find variant perception on earnings momentum and net income surprises.

    But short term trading on Macro issues? The timing is so totally impecise as to be worthless . . .

  14. B. Sneath commented on Jan 24

    “It’s also worth noting that the demographic issue in the US is comparatively benign and further in the future than in several other large economies. Japan and parts of EU come to mind. Dependency ratios are set to rise rapidly in those areas, which almost certainly means these economies will not have enough workers to maintain current output levels.”

    I agree that this issue will be less pronounced in the USA than in Japan and Europe and hopefully we will avoid Japan’s deflation as a result. It will (may) be a factor nevertheless.

    It is interesting that as we age, consumption expenditures fall dramatically in all categories (food, housing, clothing, transportation, travel and entertainment etc.) with two exceptions. The obvious one is health care. The other is hard liquor!

    Incidentially, when you look at the profile of Japan’s aging population, low birth rates and little immigration, it is likely that domestic consumption in Japan is going to continue to track lower regardless of economic policy – excluding health care and liquor, of course.

    If memory serves, age 46 is on average the year of peak consumption, at which time apparently savings for retirement begins with more earnest. Baby boomers are presently between the ages of 42 and 62.

    One would have expected the shift from consumption to savings to have begun around the year 2000 when age 46 was the Boomer mid-range.

    I recall an article a few years back that stated that the consumption to savings shift had been pushed into the future because of the high level of primarily working-aged immigration. The article went on to state that when immigration is factored in, the shift occurs not in 2000 but, get this, in 2006. (I’ll see if I can find this article on the web.)

    I am concerned that post 9/11 policies, by discouraging immigration, are having negative economic consequences. As just one example, immigrants need housing. It is a lot easier to work off a surplus of housing stock when there is higher housing demand.

  15. Fred commented on Jan 24

    “BR: In the right hand column is a Google search box for the Big Picture. Type in “ECRI” — it generates 4 pages of mentions by me of them.”

    You never hightlight their data (that I’ve seen). Those links are you repsonding to our comments.

    What do you think of their current work? What do you think of LEADING economic numbers as opposed to coincident ones?

  16. Tom commented on Jan 24

    I guess Corning’s earnings release and surprising excellent results does not fit nicely with the thesis that 4Q sales were due to discounting by retailers at the last minute to push up sales – especially when we are talking LCD screens. I guess if we ignore this data we can keep believing the sky is about to fall. No thanks, I am making money while the bears continue to pull their hair out. The permabear analysis on this site wears thin after awhile.

  17. ac commented on Jan 24

    Tom, Corporate profits can be gameplanned thus are usually overhyped. What Barry is trying to say is OVERALL nominal profits showed signs they have topped.

    If that is the case, future growth will move down.

  18. Estragon commented on Jan 24

    ” it is likely that domestic consumption in Japan is going to continue to track lower regardless of economic policy ”

    This is true, but I think the bigger takeaway is on the supply side. Japan’s peak cohort is around 60 now (around 15 years ahead of US). Demand drops off more gradually than production, since retirement tends to be an event, where the drop in demand is a process. An average retired person might consume 20% less, but will likely produce 95% less.

  19. Macro Man commented on Jan 24

    Am I the only one that is puzzled by the seeming discrepancy between the “real inflation is MUCH higher than reported” sentiment and the “sales, and therefore GDP, only boosted by much LOWER prices” sentiment? Or is it the case that the only prices that are understated are in things not sold by retailers?

    FWIW, the vast bulk of the Wall St. growth upgrades was a function of a much better than anticipated trajectory for trade, which is what you get when your currency weakens and domestic demand growth slips below trend. Note that this improvement exists both with and without oil.

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