Q1 Real GDP Was Revised Downward by the US Department of Commerce

As anticipated real GDP was revised downward by the Bureau of Economic Analysis. The revision shows a significant drop from the first estimates released in late April. Using year over year (YOY) calculations the real GDP dropped from a 3.13% growth rate in Q4 2006 to 1.90% in Q1 2007. The segments causing the large drop were primarily changes in private inventories and residential construction. Although neither of these segments comprises a large proportion of GDP the declines relative to last year are quite large.

It should be noted that personal consumer expenditure (PCE) remained relatively strong with a YOY real growth rate of 3.50%.

Here is a Reality Check of What Some Think is Really Going to Happen

From Bloomberg:

The biggest winners from the global buyout boom are hiring distressed-debt bankers in Europe at the fastest pace in five years.

``When the turn does come, it will be unlike anything we have ever seen before,'' said Iain Burnett, 43, managing director of Morgan Stanley's special situations unit in London. ``The scale of it could be considerable because of the size of some of these leveraged deals,'' said Burnett, who began his career in London a month before the October 1987 stock market crash.

Firms are paying as much as $3 million a year for bankers who advise bankrupt companies and for traders who specialize in defaulted debt, according to Heidrick & Struggles International Inc., the world's third-largest recruiting firm. That's on par with derivatives and commodities traders.

. . . . Restructuring groups are growing faster in Europe than in the U.S. as companies in the U.K., France and Germany pile on record amounts of debt, according to Standard & Poor's. . . .

. . . S&P forecasts the default rate, which was 2.3 percent in April, will rise above 2.5 percent by year-end in Europe. In the U.S., the 12-month default rate is 1.4 percent. . . .

Will China Effect the US Equity Markets Or Not . . . .

Will the Chinese stock market effect the US stock market? Two opposite views from Bloomberg on the same day.

View #1:

Even if former Federal Reserve Chairman Alan Greenspan is right, the ``dramatic contraction'' he predicts for Chinese stocks isn't likely to infect the international economy.

View #2

U.S. stock-index futures retreated after the Chinese government tripled the tax on securities transactions, sparking concern that another global rout may be in the making following drops in Asian and European indexes today.

How much risk are you willing to assume?

The Real Estate Market is Much Softer Than Previously Thought

From the consulting firm John Burns Real Estate Consulting:

The housing market has softened much more than is being reported. We have been advising our retainer clients for more than one year about misleading national sales information, both with the Existing Home Sales and New Home Sales data. We are now going public with our concerns because we are concerned that policy makers are relying on national data to conclude that the housing market correction has not been severe.

The statement gives the following reasons for the comment above:

1. Sales are down 22% in the last 12 months
2. MBA Application Index is down 18%
3. Builder order data is down 27%+
4. Brokerage business in down 18%
5. NAR data maybe understated
6. US Census data on new home sales does not net out cancellations

Lastly:

In summary, we believe that the Fed should know that the housing market correction has been quite steep and is also not showing signs of bottoming out . . .

Also there is a table at the end that is worth a look.

House Prices Drop in Q1

From Bloomberg:

. . . .The value of a house dropped 1.4 percent in the first three months of the year from the same period in 2006, according to a report today by S&P/Case-Shiller. Prices last fell during the third quarter of 1991. . . .

. . . . A recovery in housing is being held back by a wave of subprime mortgage defaults, which is throwing homes back onto the market and prompting banks to tighten lending standards for borrowers with poor or limited credit histories.

``These data are probably only just beginning to reflect the impact of problems in the subprime mortgage market,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut, in a report to clients. ``Further declines seem likely.''

New Home Construction May not Recover Until 2011

From Bloomberg this morning.

. . . New home construction in the U.S. may take until 2011 to return to last year's level, said David Seiders, chief economist for the National Association of Home Builders in Washington. Monthly construction starts would need to jump by 21 percent to reach Seiders's benchmark for full recovery, which is 1.85 million . . .

The inventory of unsold homes is the largest since the Chicago-based National Association of Realtors started counting them in 1999 and house prices have suffered the steepest drop since the Great Depression, according to the realtors' group. . . .

Sales of previously owned U.S. homes fell in April to the lowest level in almost four years, the National Association of Realtors said last week.

Housing Problems Predicted in Mid-2005

I recently cleaned up a number of paper files over the weekend and I found an interesting one from August 2005. In a USA Today article National City identified 53 cities as being overvalued.

. . . . Single-family home prices are "extremely overvalued" in 53 cities that make up nearly a third of the overall U.S. housing market, putting them at high risk of price declines, . . . .

. . . . DeKaser terms a market extremely overvalued if prices are 30% above where he estimates they should be based on historic price data, area income, mortgage rates and population density — a proxy for land scarcity. . . .

At the time DeKaser did not know what would trigger a market decline, but he knew one was coming.

A biz.yahoo.com article indicated that a number of mortgage insurance companies did a similar type of analysis where they identified a number of cities as having a real estate bubble.

The point of these analyses are that a number of firms appreciated the housing bubble and they knew it would not last forever.

Existing Home Sales are Down and Inventory for Sale is Up . . .

Existing home sales are down and inventory of houses for sale are up according an article in the Wall Street Journal. This is all occurring the strongest portion of the year to sell houses.

Sales of existing homes slipped in April to their slowest pace since June 2003, and a rising inventory of unsold properties appeared to set the stage for weaker prices.

The 2.6% decline from March, to a seasonally adjusted annual rate of 5.99 million homes, followed a revised 7.9% drop in March. April's sales rate was down 10.7% from a year earlier, figures from the National Association of Realtors showed.

The number of existing homes for sale jumped 10.4% at the end of April to 4.2 million, equal to 8.4 months' worth of sales at the current selling rate, up from 7.4 months in March. The unsold properties relative to sales hit a 15-year high.

Finally someone has addressed the issues with using median home prices without stating the mean home price.

The median home price in April of $220,900 was just 0.8% below the year-earlier level. The median price can be misleading because the mix of sales between higher-and lower-priced homes changes. Lately, there may have been fewer sales of cheaper homes because of the huge drop in subprime lending. That would tend to skew the median higher, suggesting home prices may actually be declining more than the reported median suggests.

Everyone is entitled to their opinion, but the following statement is a little baffling. Where is all the strength in housing demand supposed to come from when the strongest portion of the year is weak and most economists are projecting slow economic growth throughout the remainder of the year.

. . . . That "short-term disruption" from a meltdown among subprime lenders put April's sales pace about 5% lower than anticipated earlier, said Mr. Yun, who expects "very minimal" price declines and an overall market turnaround in coming months.

In addition, he said, the sudden rise in inventories is due in part to existing homeowners seeing an opportunity to trade up -- leading them to list their current homes on the market while they shop. "It could be implying that existing homeowners are feeling a little more confident about reentering the market," Mr. Yun said.

Below is a good example of knowing how your data is defined to make sure that you compare apples to apples. It looks like the comparison of new and existing home sales is more like apples and oranges.

Existing-home sales are recorded at settlement, so April sales could reflect contracts signed months earlier. New-home sales, which are recorded when a contract is signed or deposit made and are thus a more timely indicator of home demand, jumped a surprising 16% in April from March, the largest monthly increase in 14 years, according to a report Thursday by the Commerce Department's Census Bureau. It showed strength especially in the lower-cost South, helping median prices drop 10.9% to $229,100.

But many analysts are skeptical that new-home sales are as strong as that report suggests, noting the data are not adjusted for cancellations and are based on a small sample. Existing home sales, which include condos, townhouses and co-ops, account for about 85% of total home sales.

"The disconnect between the April new-home data and other housing-demand indicators hints that the volatile and often-revised new-home data overstate the improvement," said Richard Berner, chief U.S. economist at Morgan Stanley, in a note to clients. "And still-high inventories of unsold homes imply further downside in housing activity."

S&P’s Economist Sees More Downside in the Housing Market

The chief economist at S&P is forecasting a drop in home prices of 8% through Q4 2008.

David Wyss, chief economist at Standard & Poors, has forecast a price drop of about 8 percent for the 24-month period through the fourth quarter of 2008.

His prediction came during a general economic outlook session at the Mortgage Bankers Association's (MBA) National Secondary Market Conference & Expo in New York this week.
Housing prices will suffer from a "significant increase in defaults and foreclosures," he said, with affordability still a major issue. Wyss worried how hard the slump will hit already highly inflated housing markets.

He said its impact on areas like South Florida, where much of the buying is speculative investment in second homes, could be big. "You don't need a second home," Wyss said.

Overall, he said he expects the U.S. economy to slow this year to a growth rate of about 2.25 percent, down from 3.3 percent last year.

Celia Chen, Moody's Economy.com's director of housing economics followed Wyss' lead. "We also have an 8 percent decline in median house prices [for the 24-month period ending March 31, 2008], which is consistent with what David Wyss had."

1. There are still some wildcards in all of this:

2. excess housing inventory currently on the market,

3. people that want to sell there house, but will not sell into a weak market (shadow supply, basically supply that is not on the market yet), effects of tighter underwriting standards,

4. there are still a lot of ARMs that need to reset,

5. slowing economic growth,

6. the foreclosure problem persists and could grow,

7. not all of the credit weaknesses in the mortgage market have been flushed out yet.

8. high owner/occupied vacancy rates,

9. the appetite of the credit markets to absorb additional non-traditional mortgages.

This isn’t over by a long shot. The difficult housing market will persist into at least 2009 in some markets.

More on the Price of Gasoline at Your Pump

An interesting article in Friday’s (5/25/07) Wall Street Journal discusses the US gasoline market and some the pressures are the price.

. . . . Now, with gasoline topping an average of $3.20 a gallon nationwide, OPEC officials say they see no reason to open the oil spigot wider.

OPEC's new attitude reflects a tug of war in the global oil patch over how the profits from a barrel of oil are divvied up between the world's producers -- which develop oil deposits and pump oil -- and its refiners -- which process it into fuels like gasoline.

In recent years, the balance in the world's oil-supply system has shifted, giving the refining industry more power and more profit.

This time, OPEC says, the world has ample oil supplies. The cartel's members contend gasoline prices have climbed particularly fast in the U.S. because refining capacity is tight, imports from Europe are down, and U.S. inventories have tumbled.

. . . . OPEC officials say that if they pump more oil and depress world oil prices, U.S. gasoline prices might remain high, and the result would be even wider refining margins. In essence, OPEC would be putting more money into the pockets of refiners while its own revenue would be hurt by declining crude prices. . . .

. . . . The U.S., which imports nearly 65% of its oil, can't make enough gasoline it needs at home. It relies on imports for about 14% of its supply, and routinely imports the fuel from Europe. But tight gasoline supplies in Europe have kept the U.S. from buying as much as it would like from across the Atlantic. . . .

. . . OPEC began cutting its crude production last fall after prices for oil eased to close to $50 a barrel. As a result of the cuts, oil prices quickly rose again. Yesterday, oil closed at $64.18 a barrel on the New York Mercantile Exchange, down $1.59. In London, Brent crude, which has gained increasing prominence as a benchmark for oil prices, rose 12 cents to $70.72 a barrel. . . .

Let’s face the facts, if you worked for OPEC and believed in maximizing your profit you would do exactly the same thing.

I Hate It When the Numbers Don’t Jive

In yesterday’s (5/24/07) Wall Street Journal there was a very interesting article about discrepancies in construction employment numbers produced by the BLS. This is a critical issue to understand so the correct relationship can be made between job reallocation and recessions.

Those signs are particularly stark in the home-building industry, which has been hurt by the slump in the housing market. Housing starts in April fell 33% from their recent peak in January 2006. Yet, the number of residential-construction jobs has dropped by only about 3% over the same period.

Economists cite several possible explanations for the disparity. One is that layoffs have lagged behind the housing slump and will weaken further.

In addition, some economists say the monthly figures from the Labor Department's Bureau of Labor Statistics may be overestimating employment, perhaps by misclassifying construction workers or by failing to count large numbers of laid-off illegal immigrants.

The bureau releases two monthly employment figures: the unemployment rate, which is based on a household survey, and a tally of nonfarm payrolls, based on a survey of employers. Both are conducted through sampling and depend on voluntary responses.

A lesser-known employment snapshot, based on a quarterly census of state unemployment insurance records, shows the economy created about 19,000 private-sector jobs in the third quarter of 2006, the most recent data available. That contrasts with the 500,000 indicated in the monthly figures for that period. It also shows the number of construction jobs dropped by 77,000, in contrast with the increase of 19,000 jobs shown in the monthly surveys. . . . .

. . . . The quarterly and monthly surveys tend to follow similar long-term trends. The household survey polls 60,000 households, while the monthly business survey includes about 160,000 establishments employing a third of the nation's work force.

The quarterly census covers 97% of the civilian work force after excluding farm workers and the self-employed. Though released with an eight-month lag, it is "a more thorough accounting of the economy," said Bureau of Labor Statistics economist David Talan.

What the Heck is Pluralistic Ignorance?

Here is an excerpt from the Economist's View, but the entire post is worth a read:

... many Americans think that what they see in the major political media reflects what most other Americans really think – when actually it often doesn’t.

Psychologists coined the term “pluralistic ignorance” in the 1930s to refer to this type of misperception... A study back then had surprisingly found that most kids in an all-white fraternity were privately in favor of admitting black members, though most assumed, wrongly, that their personal views were greatly in the minority. Natural temerity made each individual assume that he was the lone oddball. ...

The OCC and Changes Ahead in the Mortgage Industry

Don’t think for a minute that John Dugan the head of the Office of the Comptroller of the Currency (OCC) is just another Washington bureaucrat with no real power. Based on this speech it appears that there are changes under foot in the mortgage industry.

. . . . he is increasingly troubled by the growing use of unverified “stated income” in subprime lending, and said he believes the federal agencies should address the practice in pending guidance.

“Sound underwriting – and, for that matter, simple common sense – suggests that a mortgage lender would almost always want to verify the income of a riskier subprime borrower to make sure that he or she had the means to make the required monthly payments,”

A comment worth repeating:

“As a result, the rapidly rising housing market of 2003-2005 was the perfect Petri dish to incubate the widespread practice of stated income loans,” he said. “At a very fundamental level, it was a bet that the increasing value of a borrower’s collateral would offset any inadequacy of the borrower’s income.”

A house is not something that you buy on margin and hope the price goes up. This is always a recipe for disaster. This reminds me of the P. T. Barnum quote "a fool and his money are soon parted".

No One Can Predict the Future, That is Why There is Risk Analysis

An recent article MSN.Money interesting. No one can predict the future and it does not pay to be either an optimist or a pessimist, but a realist. That is why there is risk analysis. All that said it pays to read contrarian points of view.

The economic and financial landscape of 2007 bears striking similarities to 1929. Back then, there were large, unregulated pool operators and other insiders constantly muscling the tape in whatever direction they chose. The public, too, was involved, thinking the country was experiencing a new era. Meanwhile, business began deteriorating in the spring of 1929, though the partying in stocks lasted until the fall.

One comment that is worth re-stating:

Make no mistake about it: The tightening of credit has (and will) radically alter the housing market -- witness the softening of home prices nearly everywhere in the country as inventory builds and sales slow.

Also keep the position of Wall Street and the consumer separate:

The deteriorating economy is a process that has a long way to go, even though Wall Street tries to throw a party every day that bad news does not absolutely pummel it into submission. No amount of hedge-fund and LBO speculation is going to make the average consumer whole again.

Greenspan Speaks on China

From Bloomberg :

Former Federal Reserve Chairman Alan Greenspan said he was concerned Chinese stocks might undergo a ``dramatic contraction'' after its main stock index jumped more than 90 percent this year.

The benchmark CSI 300 Index, which tracks yuan-denominated A shares listed on China's two exchanges, rose to a record 3938.95 today. The index more than doubled last year as investors bet corporate profits would be boosted by the world's fastest-growing major economy.

``It is clearly unsustainable,'' Greenspan told a conference in Madrid today by satellite. ``There is going to be a dramatic contraction at some point.''

3 things China has done to slow down its economy are:

1. The People's Bank of China on May 18 announced it will let its currency rise or fall 0.5 percent a day, up from 0.3 percent.

2. The central bank also raised interest rates for a fourth time in the past year

3. and ordered banks to put aside more money as reserves.

A somewhat more dramatic spin on China from Nouriel Roubini:

``The Chinese have lost control of monetary policy and now it has reached the stock markets,'' said Nouriel Roubini, chairman of Roubini Global Economics LLC in New York. ``There's a bubble, and eventually it's going to collapse.''

By the way, Chairman Greenspan is sticking with his previous prediction of a chance of a recession in the US this year at 1/3.

What Causes Economic Recessions?

Based on a Google search concerning this issue it appears that this is a tough problem for professional economist as well. In a brief article published by the Federal Reserve Bank of Boston (FRBB) written almost 10 years:

. . . . what causes economic downturns is still a largely unsolved puzzle. The traditional explanation is that recessions are caused by events that have an economy-wide impact, such as an increase in interest rates or a decline in consumer confidence. Firms reduce output and lay off workers, which further decreases demand, and the economy slows even more.

But, some firms add staff during recessions, even as others are reducing their workforce. So some economists have suggested that recessions might be caused not by economy-wide changes, but by events that hurt particular firms or industries. They speculate, for example, that a major innovation or a change in the price of a key input can adversely affect some firms, causing them to reduce production and discharge workers, while other firms are helped and seek additional workers. Since it takes time for displaced workers to find jobs with new employers, a recession may occur during this period of "reallocation."

The recessions that followed the dramatic increases in the price of oil in 1973 and 1979 were due, at least in part, to such changes. Businesses for which demand was sensitive to energy prices, such as full-sized cars, suffered a sharp decrease in orders and were especially likely to contract. Those that required a lot of energy to run machinery faced higher-than-typical cost increases and were also more likely to reduce output and staff. It took time for displaced workers and other resources to be reemployed elsewhere. In the meantime, the economy experienced a recession. further decreases demand, and the economy slows even more.

This is similar to comments made by Joe Ellis in his book Ahead of the Curve, where he more pragmatically uses real hourly wages of production workers to predict a recession. If corporations layoff workers wages will decline, thereby further decreasing demand.

The authors of the FRBB article further state further that:

Most recessions involve a tangle of forces. The 1970s' oil shocks also set off an economy-wide decline in demand as real income was reduced by the higher cost of oil imports and tighter monetary policy dampened the inflationary pressures which followed the price increases. These factors slowed overall demand, and so were also partly to blame for the subsequent recessions. And, such a drop in demand may cause further job destruction. Thus, aggregate forces can play an important — perhaps even a dominant — role in recessions, even if allocative forces provide the trigger.

Yet, paying attention to forces that can produce reallocation may help us spot the seeds of future slowdowns and bursts of growth.


A good point in this discussion is something that I always thought, but have not been able to prove which is that for an economic recession to develop the economy needs a catalyst to “push it over the edge”. The recessions of the 1970s and 1980s had high oil prices that caused significant reallocation of workers as stated above and the recession in early 2001 had the decline in the number of computer people needed to handle Y2K.

The $64,000 (estimated to be $452,399 in today’s dollars) question is: What is the significant force in today’s economy that could cause a recession. Is it the continuing unemployment in the construction industry due to the decline in housing? Is it the unemployment that will eventually occur in the finance industry due to the decline in housing? Is it the inability of the consumer with high levels of debt to continue spending due to restricted cash flow? Is the spending squeeze that consumers will feel as the price of energy increases? Or are we witnessing the development of the Perfect Storm because it is the combination of all these issues.

At this point one can only speculate.

Some Quick Headlines on US Oil Refining Capacity:

Below are some articles on US oil refining capacity that are very interesting and very timely. Each looks like it is a recent article associated with the current high price for gasoline. The point is that each of these articles is from 2005 or before. Make no mistake oil refining capacity issue has been discussed for some time.

U.S. refiners stretch to meet demand

A push to build new US refineries

U.S. Shortage of Oil Refining Capacity Called Critical

Oil-refinery capacity

Yes, the price of gasoline depends on the price of oil, but gasoline markets are regional and depend very much on regional demand, inventories, transportation, and refining capactiy. A good discussion of the refining capacity in the US can be found in the study by ICF Consulting.

Definitions for an Economic Depression and Stagflation


Because a number of people seem to be so interested in having a few more terms defined, here are a few more:

Economic Depression – like an economic recession there is no agreed upon definition of an economic depression other than it is a severe recession.

The World Bank defines a depression as: A period marked by low production and sales and a high rate of business failures and unemployment.

About Economics defines an economic depression as a period in which the real GDP growth is -10%.

The Great Depression lasting much of the 1930s in the US and Europe was the last depression in a developed economy. There have been, however, significant slumps in a number of Latin American economies in the 1980s, former Soviet Union economies of eastern Europe in the 1990s, and some have called the economic slump Japan has witnessed in the 1990s an economic depression.

A number of people believe that the probability of another depression in the US is relatively high. These people, however, do not take into account the failures of the monetary and fiscal policies of the US and other countries in the 1930s, which in fact allowed the economies to decline into a depression. Since that time a great deal of research has been completed to understand the causes of the Great Depression. Go to Amazon.com and enter Great Depression to see the books that have been written on the subject. Also the current Chairman of the Federal Reserve, Ben Bernanke, has a book on the subject entitled Essays on the Great Depression. I do not believe that the likelihood of another economic depression in the US is very high at this time. Although ask me 6 months from now, I may have another point of view.

Stagflation – a period of slow economic growth, relatively high unemployment, and high inflation.

The US and many other developed economies suffered from stagflation in the 1970s resulting from high oil prices.

Some believe that the US is possibly facing another period of stagflation as the economy softens and oil prices rise. Although there is a possibility of this occurring I do not believe that it is likely. A doubling or tripling of the price of oil would have to occur, which at this time would more than likely result from some type of catastrophic event and not the price hikes by the OPEC cartel as occurred in the 1970s.

WSJ Story on Retail Sales . . .

The Wall Street Journal reported on Friday that there was a decline in retail sales of 2.3% in April.

Major retailers reported a collective 2.3% decline in same-store sales, or sales at stores open at least a year, according to an index of 51 leading chains compiled by the International Council of Shopping Centers.

This news has been in a number of news sites or blogs and it caused quite a drop in the markets (the DJIA lost 85 points or 0.64%) on Thursday when the news came out. But the interesting thing to me was the differences in the stores and their size by sales. Looking at the same store numbers most retailers were down. The notable exception is the higher-end retailers (Saks, Nordstrom’s, and Neiman Marcus), which all had increases the same period. The discount and mid-level stores where most US consumers shop (about 99% of sales for the stores in the survey) are down in sales.

The point - discount and mid-level stores drive consumer sales.

Another Take on Q1 and Q2

Although most economist are optimistic about Q2, a different opinion can be found at Nouriel Roubini website.

Based on a variety of data that have come out after the first estimate of Q1 US growth at 1.3% it is now likely that US growth in Q1 was actually below 1% (probably close to 0.7%); we are thus already into a “growth recession” territory. As discussed extensively in this blog a US hard landing can take two forms: a “growth recession” i.e. a period of time when growth is well below potential and in the 0% to 1% range; or an outright recession, i.e. two consecutive quarters of zero growth.

. . . The revisions of Q1 GDP growth that will push the revised estimate of Q1 growth rate below 1% are:

- Lower change in inventories than initially estimated reducing Q1 growth
- Better construction spending than initially estimated increasing Q1 growth
- Much worse trade balance in March than initially estimated reducing Q1 growth

The net effect of these three factors is an estimated 0.7% growth for Q1 (JP Morgan today revised its Q1 estimate downward to 0.8%).

Much more seriously, Q2 started on a very weak note for private consumption based on initial estimates of retail sales. I now expect Q2 growth to be closer to 0% or even negative (i.e an outright recession).

Please note that Dr. Roubini has been predicting a recession for some time. His initial estimates were that it would start in Q1 2007. His estimates are constantly stymied by the persistent consumer and their ability to spend.

Chances are the Economic Growth for Q1 2007 Will Be Revised Downward . . .

The GDP estimates for Q1 2007 will more than likely be revised downward after a wider trade gap and lower inventories according to Bloomberg.

"The U.S. trade deficit in March jumped 10 percent to $63.9 billion, the widest since September, the Commerce Department reported yesterday. Stockpiles in March unexpectedly fell by the most since July 2005, Commerce reported today."

Economists now forecast first-quarter growth, reported last month at a 1.3 percent annual rate, may actually have been as low as 0.5 percent."

"Still, leaner inventories and stronger demand in March brighten the growth outlook for this quarter, economists said. "

"In its April 27 advance report on gross domestic product the Commerce Department said the trade deficit subtracted 0.52 percentage point from growth in the first quarter, while inventories shaved off another 0.3 percentage point. "

Did You Ever Wonder Your Numbers Don’t Look Like Theirs . . . . .

One of the problems I noticed about much of the reporting in the press, news, or on the internet is the numbers don’t always jive. For example, economic growth (real GDP) discussed in the media and furnished by the US Dept. of Commerce is defined on a quarter over quarter (QOQ) basis. The real GDP for Q4 2006 is 11,513.0 and for Q1 2007 is 11,549.1, therefore, the calculation of economic growth is

(11549.1 – 11513.0)/11513.0 = 0.31355%

Because this is quarterly data to get an annual growth rate you multiply by 4

0.31355% * 4 = 1.25%

The same calculation for a year over year (YOY) estimate of economic growth is

Q1 2006 real GDP = 11,316.4
Q1 2007 real GDP = 11,549.1

(11549.1 – 11316.4)/11316.4 = 2.0563%

Hmmm! Numbers are pretty different 1.25% using the QOQ method versus 2.06% using the YOY method.

This is a common problem, knowing how calculations are made so comparisons can be apples to apples and not apples to oranges.

By convention the US Dept. of Commerce discusses changes in economic growth on a QOQ basis. On the other hand I tend to do both YOY and QOQ, but I tend to emphasize the YOY values. The QOQ method tends to gives results similar to the YOY method, but with greater variability or a higher level of noise (double click on the graph for a larger image).

For those of you that like numbers the average economic growth for the period 2002 Q1 though 2007 Q1 using the QOQ method is 2.93% with a standard deviation of 1.53%. Using the YOY method the same values are 2.87% and 0.93%. Clearly the average levels of economic growth are very similar using both methods, but the variability using the QOQ is almost 65% higher.

A good discussion of the value of the QOQ versus the YOY method can be found in Ahead of the Curve by Joe Ellis.

The point of this little exercise is not that one method is better than another, it is just one should know whether the analysis uses QOQ, YOY, or MOM (month over month) and know the positives and negatives of each method.

The FED and the Consumer

These excerpts came from an article in Bloomberg today that I think correctly summarizes the position of the Federal Reserve and the US consumer:

The Fed kept the benchmark interest rate at 5.25 percent for a seventh meeting today and said inflation remains the ``predominant'' risk for the economy.

If the inflation rate is running at 3% per year and nominal GDP growth is 3% then the growth rate in real GDP is 0%. I don't think the fear is inflation as much as anemic GDP growth.

``The consumer is stressed,'' said Gregory Miller, chief economist at SunTrust Banks Inc. in Atlanta. ``Energy prices don't look like they'll moderate, housing is still in a morass and the labor market has slowed conspicuously.'' Still, ``the Fed is going to stick to their guns and guard against inflation.''

This stress is due to slowing hourly wage growth, increasing unemployment, a difficult housing market, and increasing fuel prices. Additional weak growth in real PCE is expected through at least year end.

What I think is the most important comment in the article:

``I don't think the Fed has got a lot of room for maneuver,'' said Nigel Gault, chief U.S. economist at Global Insight Inc. in Lexington, Massachusetts. ``At this point, growth hasn't deteriorated enough to allow the Fed to cut rates, while inflation is still above their comfort zone.''

Consumer Debt Increased in March by $13.5 Billion

From an article in Bloomberg

Consumer credit, or non-mortgage loans to individuals, increased $13.5 billion, or 6.7 percent at an annual rate, to $2.425 trillion, the Fed said today in Washington. In February, consumer debt rose $5.6 billion. . . .

The increase in consumer credit in March was the largest since a $20.1 billion gain in November, according to Fed statistics. . . .

. . . . Revolving debt, such as credit cards, rose $6.8 billion in March after rising $2.2 billion a month earlier, according to the Fed's statistics. Non-revolving debt, such as auto loans and mobile home loans, rose $6.7 billion for the month after increasing $3.4 billion a month earlier.

Consumer borrowing is up in March, unemployment is up in April, real hourly wages are up in March and April but at a slowing rate, and the total number of hours worked in April is down.

Is the consumer seeing a slowing economy and lower incomes so borrowing has increased to maintain their consumption patterns?

The US Consumer - Still Kickin'

A recent article in CNN Money.com was interesting because it spoke directly to the issue of consumer spending. Consumer spending, officially known as Personal Consumption Expenditures (PCE), comprises 70% of real GDP and is therefore, the driving force as to whether or not the US economy has a soft landing or a recession. PCE is made up of durable and non-durable goods consumption and the consumption of services.

PCE is a function of income growth and the number of employed in the economy.

"Income growth is the No. 1 risk to spending. The other is jobs," . . . . "These [two indicators] would be the deciding factor on whether or not consumers will have the ability to keep shopping in the months ahead," . . .

The next big test as to how the consumer is feeling about consuming will be when school starts.

. . . . his point of clarity will come in a few months as retailers prep for the critical back-to-school shopping season.

"That's the second biggest selling season for stores after Christmas, . . . The sales numbers in July, August and September will be crucial and we'll better know about the state of consumers by October."

What is a Recession, Anyway?

Yesterday morning while watching CNBC I listened to two individuals debate whether or not the US would have recession. One commentator thought there would be a recession and the other thought there would be a “soft landing” for the US economy. What exactly is a recession, a soft landing, and a hard landing?

It seems that although everyone talks about recessions there is no official agreed-upon definition. According to the National Bureau of Economic Research (NBER) :

The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP.

The NBER is the organization that officially defines a recession in the US. Although it does not use an exact definition a recession is generally defined as:

. . . . a recession-the way we (NBER) use the word-is a period of diminishing (economic) activity . . . .. We identify a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when the economy is contracting.

. . . Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. . .

In addition:

The NBER considers real GDP to be the single measure that comes closest to capturing what it means by "aggregate economic activity." The committee therefore places considerable weight on real GDP and other output measures. Following the precedents established in many decades of maintaining its business cycle chronology, however, the committee considers a wide range of indicators of economic activity. There is no fixed rule for how the different indicators are weighted.

ADVFN website defines a soft landing as:

A term describing a growth rate high enough to keep the economy out of recession, but also slow enough to prevent high inflation and interest rates.

By the way, a hard landing is a recession.

More on recessions, soft landings, etc. in later posts.