Saturday, December 26, 2009

Inventories and Q4 GDP

by Bill McBride on 12/26/2009 05:49:00 PM

Back in October, as a preview to the Q3 GDP report, I wrote: Inventory Restocking and Q3 GDP

I noted that GDP growth in Q3 and Q4 weren't in question because of a transitory boost from changes in private inventories and from stimulus spending.

Here is a repeat of the graph showing the contributions to GDP from changes in private inventories for the last several recessions. The blue shaded area is the last two quarters of each recession, and the light area is the first four quarters of each recovery.

Inventory Contribution to GDP Click on graph for larger image in new window.

The Red line is the median of the last 5 recessions - and indicates about a 2% contribution to GDP from changes in inventories, for each of the first two quarters coming out of a recession.

The key is this boost is transitory.

Last quarter I thought a 1% to 2% contribution from changes in inventories was possible. The actual contribution was 0.69%. I suspect that changes in inventories will add more to Q4; probably closer to 2%.

I also thought Personal Consumption Expenditures (PCE) would be fairly strong in Q3, especially because of the cash-for-clunkers program. My guess was "3% PCE growth in Q3, and that would mean a contribution to GDP of about 2%." The final numbers were 2.8% and a contribution of 1.96%.

The following graph shows real Personal Consumption Expenditures (PCE) through November 2009 (in 2005 dollars). Note that the y-axis doesn't start at zero to better show the change.

PCE The quarterly change in PCE is based on the change from the average in one quarter, compared to the average of the preceding quarter.

The colored rectangles show the quarters, and the blue bars are the real monthly PCE.

Using the "two-month method" for estimating Q4 PCE growth gives an estimate of just under 1%. However - note that PCE in August was distorted by the cash-for-clunkers program (and that impacts the two-month method). So my guess is PCE growth in Q4 will be around 1.7% or a contribution to GDP of 1.2% or so. (less than the growth in Q3).

As I've noted, residential investment has been moving sideways, although that will show up more in Q1 2010 than in Q4. So we can add in a positive contributions from net exports, some increase in residential investment (although smaller than in Q3), an increase in equipment and software investment - and subtract out investment in non-residential structures - and Q4 should look pretty healthy.

In a reserach note this week, Ed McKelvey at Goldman Sachs called the 2nd half "ho-hum":

"At a time of the year when ho-ho-ho is the catchword, the first six months of the US economic recovery look distinctly ho-hum following the latest reports. ... Although we continue to estimate a 4% growth rate for the fourth quarter, with upside risk to that figure, the composition of this growth is not strong. Almost half of it comes from a sharp slowing in the rate at which inventories are being drawn down ..."
Impact of Stimulus And it is probably a good time to repeat this graph from's Mark Zandi suggesting the greatest impact from the stimulus package is now behind us.

This suggests that all of the growth in Q3 was due to the stimulus package (and then some), and the impact is now waning - only 2% in Q4, and 1.5% in Q1 2010 - and then the impact on GDP growth will be negative in the 2nd half of 2010.

As "ho-hum" as the 2nd half of 2009 was, I expect GDP growth to be more sluggish in 2010 for the following reasons:

  • Most of the increase from changes in private inventories will be behind us - although it could slip into Q1 2010, but without a pickup in end demand, the boost will end soon.

  • Because of the huge overhang of vacant housing units, I expect any increase from residential investment to be muted.

  • I expect the personal saving rate to increase over the next year - leading to slow PCE growth.

  • Non-residential investment in structures will be a drag throughout 2010.

  • And as I noted last quarter, on the plus side, exports might continue to provide a boost.

    So I still think GDP growth will be sluggish in 2010, with downside risks.

    Note: There are several upside and downside risks to this view.