Renowned economist David Rosenberg wrote last July that stocks were getting ahead of themselves, backed up with a compelling argument: "[F]or the market to build on such a rapid advance in the current quarter, history ... suggests that we would need to see 5.5% real GDP growth, which we give near-zero odds of occurring."
Few argued. The thought of 5.5% GDP growth was insane. "Near-zero odds" seemed about right.
Lo and behold, fourth-quarter GDP figures are due out Thursday, and average economist estimates call for growth of ... 5.5%. One Goldman Sachs
What the heck happened? Say these estimates are right, and fourth-quarter GDP growth really is near 5%. Are we saved, or what?
Lots of numbers, few takeaways
Perhaps, but here's what you should know. Only two parts of a GDP report are truly important:
- What segments the growth (or decline) comes from.
- Whether factors fueling the change are sustainable.
Here's an example from the third quarter of 2009. For the quarter, 2.2% GDP growth was achieved by:
|
Segment |
Contribution to Q3 GDP Growth |
|---|---|
|
Personal Consumption |
1.96% |
|
Gross Private Domestic Investment |
0.54% |
|
Net Exports |
(0.81%) |
|
Government Spending |
0.55% |
|
Total |
2.2% |
Source: Bureau of Economic Analysis.
It's now well known that most of Q3's personal-consumption gain came from "Cash for Clunkers." Of course, this program juiced monthly sales at Toyota
Should we assume the same for Q4?
Kind of
We don't have fourth-quarter numbers yet, and I won't pretend to know what they'll say. But substantially all forecasts are prefaced with the same warning: The headline growth numbers will be driven almost entirely by a stabilization of inventories.
When a recession strikes and sales decline, companies liquidate inventory that might otherwise sit idly on the shelves. Big sales. Big promotions. Everything must go.
If we look back to Q1 2009, we see that the impact that inventory reductions had on GDP was shocking: Total GDP fell by 6.4%, 2.36% of which was attributable to declines in inventory. That drop simply crushed the economy.
But these fire sales were so ferocious that companies now need to start restocking. That situation leads to increased production (you win again, business cycle). And since current numbers are being compared with the destruction of last year, even a small improvement means a large percentage gain. This scenario is probably going to reveal itself in a big, big way on Thursday.
What next?
Inventory restocking is real, legitimate growth. It's part of the natural recovery process. Praise it, welcome it, cherish it. It's wonderful.
What it is not, however, is sustainable.
Remember companies that slashed costs over the past year to keep net income up? Starbucks
That's a perfect analogy for why inventory restocking should be discounted. It's a passing impact to GDP growth that probably won't last more than a quarter or two.
History doesn't lie
The Calculated Risk blog gives a great historical example of this. After the 1980 recession, inventory changes alone increased GDP by 6.4% in early 1981. But ...
Since there was no pickup in underlying demand, the economy slid back into recession in July 1981. Now the causes of the current recession are very different from the early '80s, but once again we are seeing a transitory boost from inventory changes and underlying demand remains weak.
Bingo: Underlying demand remains weak. Sustainable economic growth needs underlying demand from either consumer spending or exports. Counting on consumers to save the day seems lost, because the household debt monster hasn't gone away. Relying on exports (while helped by a weak dollar) seems equally far-fetched, since exports make up a small portion of the overall economy and are largely overshadowed by a still-gluttonous appetite for imports.
Maybe David Rosenberg was on to something.
