by Bill McBride on 1/29/2010 10:57:00 AM
Friday, January 29, 2010
Any analysis of the Q4 GDP report has to start with the change in private inventories. This change contributed a majority of the increase in GDP, and annualized Q4 GDP growth would have been 2.3% without the transitory increase from inventory changes.
Unfortunately - although expected - the two leading sectors, residential investment (RI) and personal consumption expenditures (PCE), both slowed in Q4.
Note: for more on leading and lagging sectors, see Business Cycle: Temporal Order and Q1 GDP Report: The Good News.
It is not a surprise that both key leading sectors are struggling. The personal saving rate increased slightly to 4.6% in Q4, and 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.
And there is no reason to expect a sustained increase in RI until the excess housing inventory is absorbed. In fact, based on recent reports of housing starts and new home sales, there is a good chance that residential investment will be a slight drag on GDP in Q1 2010.
Click on graph for larger image in new window.
This graphs shows Residential investment (RI) as a percent of GDP since 1947.
RI had declined for 14 consecutive quarters before the increase in Q3 2009. The Q4 report puts RI as a percent of GDP at just over 2.5%, barely above the record low - since WWII - set in Q2 2009.
Notice that RI usually recovers very quickly coming out of a recession. This time RI is moving sideways - not a good sign for a robust recovery in 2010.
The second graph shows non-residential investment as a percent of GDP.
Business investment in equipment and software increased 13.3% (annualized). This is a good sign, but continued investment probably depends on increases in underlying demand.
Investment in non-residential structures was only off 15.4% (annualized) and will probably be revised down (this has happened for the last few quarters). I expect non-residential investment in structures to continue 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.
The transitory boost from inventory changes is frequently a great kick start to the economy at the beginning of a recovery - as long as the leading sectors (PCE and RI) are also picking up. This report has to be viewed as concerning ... and is reminiscent of Q1 1981 and Q1 2002 ... both examples of inventory changes making large contributions to GDP, but underlying growth remained weak.