Thursday, October 29, 2009

Random Thoughts on the Q3 GDP Report

by Bill McBride on 10/29/2009 07:29:00 PM

After the Q1 GDP report was released, I wrote: GDP Report: The Good News. The headline number in Q1 was ugly, but there was a clear shift in the negative GDP contributions from leading sectors to lagging sectors.

Here is a repeat of the table from that earlier post showing a simplified typical temporal order for emerging from a recession:

When Recovery Typically Starts

During Recession Lags End of Recession Significantly Lags End of Recession
Residential InvestmentInvestment, Equipment & Software Investment, non-residential Structures
PCEUnemployment(1)

(1) In recent recessions, unemployment significantly lagged the end of the recession. That is very likely this time too.

Now look at the Q3 GDP report from leading to lagging sectors:

  • Residential investment was up at a 23.4% annualized rate, breaking a streak of 14 straight quarterly declines, and contributing 0.53 to the percent change in GDP.

  • Personal Consumption Expenditures (PCE) was up at a 3.4% annualized rate, and contributing 2.36 to the percent change in GDP.

  • Investment in Equipment & Software was up slightly at a 1.1% annualized rate.

  • Investment in non-residential structures was down 9.0% at an annualized rate.

    This is exactly what I'd expect a recovery to look like.

    Unfortunately ... the two leading sectors, residential investment (RI) and personal consumption expenditures (PCE), will both be under pressure for some time. The Census Bureau report this morning showed that there are still far too many excess housing units (homes and rental units) available. There cannot be a sustained recovery in RI without a boom in new home sales and housing starts, and it is difficult to imagine a boom in new home sales with the large overhang of housing units.

    It takes household formation to reduce the excess inventory, and household formation requires job creation so that individuals and families will feel more confident and move out of their parent's basements. Some day there will be a boom in household formation, once job creation returns, but usually the first jobs in a recovery are from RI and PCE - so the economy is in sort of a circular trap.

    That is why we need policies aimed at job creation and household formation. As housing economist Tom Lawler wrote today in a note to clients: "policies that move renter households into owned homes but that don't stimulate household formations MAKE MATTERS WORSE!"

    And the other leading sector, PCE, is also under pressure. The personal saving rate declined in Q3 to 3.3%, but the decline was probably temporary. I expect the saving rate to increase over the next year or two to around 8% - as households repair their balance sheets - and that will be a constant drag on PCE.

    I expect Q4 GDP to be similar to Q3, however I think growth in 2010 will be sluggish - with downside risks. I think RI and PCE will be sluggish in 2010, and the stimulus will fade (and become a drag in the 2nd half of 2010).

    Here is a look at investment:

    Residential Investment as Percent of GDP Click on graph for larger image in new window.

    Residential investment (RI) had declined for 14 consecutive quarters, and the increase in Q3 2009 was the first since 2005.

    This puts RI as a percent of GDP at 2.5%, just barely above the record low - since WWII - set last quarter.

    Non-Residential Investment as Percent of GDP The second graph shows non-residential investment as a percent of GDP.

    Business investment in equipment and software increased 1.1% (annualized), breaking a streak of 6 consecutive quarterly declines.

    Investment in non-residential structures was only off 9.0% (annualized) and will probably be revised down (this happened last quarter). I expect non-residential investment in structures to decline sharply over the next several quarters. In previous downturns the economy recovered long before nonresidential investment in structures recovered - and that will probably be true again this time.

    When the supplemental data is released, I'll post graphs of investment in retail, offices, and hotels, and a breakdown of residential investment.

    Some possibly interesting notes:
  • Much was made yesterday of Goldman Sachs Q3 GDP forecast of 2.7%. My understanding is the reason the forecast was a little low was because they underestimated changes in private inventories. Goldman forecast this boost would happen in Q4, so they will probably revise down their Q4 forecast.

  • The two month method for predicting PCE suggested a 3.6% real growth rate (annualized). There was a little slowdown in September, but once again this was close to the reported 3.4% change.

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