US Perspectives: GDP Growth Not as Disappointing as It Looked

A closer look at the details of Friday's GDP report reveals that a massive inventory adjustment torpedoed the top-line number.

Robert Johnson, CFA 01.02.2011
Facebook Twitter LinkedIn

Last week, geopolitical news out of Egypt took the stage and dwarfed both economic news and earnings reports. Unrest in the Middle East always raises the specter of higher oil prices, which are already becoming problematic for the economy. In addition, potential threats to the Suez Canal, which adjoins Egypt, raise concerns about one of the most important shipping lanes in the world. Any interruption could slow worldwide economic growth.


Economic News Could Have Been Better, but the Bar Was Set High

On the economic front, fourth-quarter GDP growth of 3.2% appeared to disappoint investors, though a closer look at the details reveal that a massive inventory adjustment torpedoed the top-line number. Consumer data contained within the report (which drives long-term GDP growth) were ahead of expectations. Separately, housing data were on balance positive, while initial unemployment claims continued to yo-yo up and down. Weather- and holiday-related processing catchups caused yet another spike in claims last week that will most likely be reversed again this week


Earnings News Was Nothing to Write Home About

Earnings news last week was mixed. Tech and manufacturing continue to surprise on the upside, while retailers and financial institutions are having a harder time meeting high expectations. Two higher-profile names, Ford and Amazon, disappointed last week, but for all the right reasons. Ford's revenue was fine, but costs of new car launches and debt extinguishment weighed on results. Amazon's results disappointed as the firm continued to invest in infrastructure and technology. It's good to see businesses willing to finally make additional capital expenditures in pursuit of long-term growth.


Inventory Adjustment Sinks Stellar GDP Report

The inventory adjustment factor sunk what would have otherwise been a stellar GDP report. Still, GDP growth did manage to accelerate from 2.6% in the third quarter to 3.2% in the fourth quarter versus my estimation of a 4% increase. GDP has now officially recaptured every bit of what was lost during the 18 months of the recession. Beyond inventories and slowing government spending, every category outperformed expectations. Rock-bottom inventories and the payroll tax cut to be implemented in January should lead to an even higher GDP growth rate in the first quarter.


Consumer Spending Outpaces Incomes

My only real concern in the GDP report is that consumption grew faster than incomes. The savings rate fell from 5.9% in the previous quarter to 5.4% in the fourth quarter (its quarterly high was just over 7%). This suggests that purchases were made from stock market profits and, possibly, anticipation of the payroll tax cut and settlement of many open tax issues after the election. However, consumption can't outgrow incomes for extended periods of time. That is why after two years of pooh-poohing soft employment numbers, they are now the central focus of my analysis. To be technically correct, I said employment statistics are severe laggards, not that they are irrelevant at all times. Now is the time for the employment report to take center stage.


Consumer Spending Accelerates

Again, the consumer represents the largest (at 70% of GDP) and most important part of the GDP report. Without consumer demand there would be no need for business investment and increased inventories. Here the news was stunningly good as consumer spending growth accelerated to 4.4%, ahead of my 4.0% estimate. This represents the fastest quarterly growth rate in consumer spending in more than five years. It also represents a sharp acceleration from recent quarterly trends.


Consumer Spending Growth

3Q 2009

4Q 2009

1Q 2010

2Q 2010

3Q 2010

4Q 2010







Source: Bureau of Economic Analysis


We will learn on Monday whether the growth accelerated throughout the quarter when the monthly personal income and spending data are released. My guess is that growth probably decelerated through the quarter. Normally, such a deceleration would be problematic, setting up for a meaningfully weaker first quarter. However, a lot of the deceleration was at least partially due to early holiday promotions that shifted consumer purchases away from December and into November and especially October. That shift makes the deceleration look less troubling. In addition, the payroll tax cut should also aid first-quarter spending performance.


Sharp Spending Increases Hurt Inventory Calculations

This sharp acceleration in spending caused inventories to grow much more slowly than sales. Some of the inventory issue was because production couldn't keep pace with demand, forcing inventory/sales ratios down to unsustainably low levels. Another portion came from the importation and storage of a lot of foreign goods during the first three quarters of the year. Those goods were shipped from inventory in the fourth quarter. Shipments out of inventory do not count in the GDP calculation. Remember that the "P" in "GDP" stands for production, not inventory drawdowns. The rather obtuse inventory adjustment reduced GDP a stunning 3.7%. It is important to note that inventories were not at a very high level to begin with. Some of those inventories will need to be replenished in 2011.


But the Inventory Issues Are Partially Explained by Falling Imports

It is tempting to say GDP growth would have been 6.9% without the inventory adjustment, which is mathematically true. However, there is an interaction between imports and inventories that would make this a less-than-honest assessment. Earlier in the year, there was an unusually high amount of imports, some of which probably ended up in inventory, awaiting the holiday sales period. In the fourth quarter imports were much lower than they would have normally been. Like inventories, imports are a subtraction from GDP because they represent goods not produced here. Falling imports added a remarkable 2.4% to GDP. Combining the inventory and import-related over-reactions, I suspect that the GDP growth tendency for the fourth quarter was just over 4% versus the 3.2% reported.


Exports, Business Spending Looking Good...Government, Not So Much

I think the consumption numbers, the inventory adjustment, and the import numbers tell most of tale in the fourth-quarter report, but there are a few other points of interest.


Export growth remained strong, contributing just over 1% to GDP growth as strong emerging markets and agricultural categories moved things along. Business spending was a small contributor, but it was held back by a sharp decline in transportation equipment that looks just a little fishy.


Government spending on all levels fell 0.6%, subtracting a miniscule amount from GDP. Whether the proverbial other shoe has fallen in the government spending category remains to be seen. For all the whining and gnashing of teeth, total government spending is actually up on a fourth quarter over fourth quarter basis. Even the state and local government subcategory is down less than 1% year over year. The only other point of contention in the report is that consumer spending on services remains lethargic, growing just 1.7%, flat with the growth rate of the past two quarters and far below total consumer spending growth of 4.4%. The complete GDP breakdown appears below.


Consumer in the Driver's Seat

Sources of GDP Growth


% Total GDP

Growth %

to GDP Growth %

Consumer Goods





Consumer Services





Business Structures





Business Equipment & Software





Homes, Improvements, Commissions





Change in Private Inventories




















State and Local










Gross Domestic Product





Source: Bureau of Economic Analysis, Morningstar Calculations


Housing Data Hanging In There

Housing data last week showed that prices continued their very slow fall, new home sales accelerated, albeit from special regulatory factors, and pending home sales increased yet again. As shown in the GDP report above, housing isn't a huge direct contributor to GDP at this time, comprising just 2.4% of GDP. However, even that number overstates the impact as brokerage commissions and remodeling projects are included in this category in addition to new construction. To put that number in perspective, the direct residential component of GDP was well over 6% in late 2005. Though unlikely to be much of a contributor in 2011, the long-term upside potential for housing is multiples of the downside risk.


Data Inconsistencies Render the Durable Goods Report Nearly Useless

Eric Landry, head of our manufacturing team offered the following commentary on the normally important durable goods order report:  

December orders for durable goods dropped 2.5% from November on a seasonally adjusted basis. The latest data are only 7% above year-ago results, a marked deceleration from the more than 10% growth in the previous 11 months. If the volatile transportation sector is excluded, however, annual growth was a more respectable 11.5%, just slightly below November's level and ahead of October. We'd be surprised if the nondefense aircraft and parts category wasn't revised in the coming months, as December registered a 99.5% sequential (yes, sequential) drop to just $24 million from over $5 billion. Other notable movements include a 10.6% sequential increase in machinery orders. By and large, we don't think the latest durables data indicate much slowing in the industrial cycle.

House Price Declines Moderate, Potential Good News Ahead

On the pricing front, the Case-Shiller 20-city price index fell 1.0% (three-month trailing average basis) ending in November, which is a slight improvement from the 1.3% fall during October. On a year-over-year basis prices are down 1.6%. However, compared to the lows of 2009 prices are up 3.3%, even after factoring in the declines of the last three months.


Remember, too, that the 20-city index declined 30% between the mid-2006 top and current levels. Morningstar's team notes that the rate of decline slowed in many markets in November. In addition, their real-time listing price database (which is not as conceptually accurate as the Case-Shiller data) is showing signs of improvement, which should work its way through the greatly delayed Case-Shiller statistics in the months ahead.


Pending Home Sales Jump Artificially

While new home sales jumped almost 17.5% in December to 330,000, I caution that this statistic was inflated by an upcoming change in California building codes. These code changes make new homes more expensive and caused an acceleration in sales in the Western region report. I would suspect these figures could drop back again in January. Don't get too excited by the good numbers in January and don't get panicked by February's decline.


Finally, pending home sales increased 2%, boding well for the next several months of existing home sales. The pending home sales index has moved up during five of the last six months. Given the recent strength of existing home sales, I thought the pending sale index might take a breather in January. Existing home sales have gone from a credit expiration bottom of 3.8 million units to 5.28 million units in six months. That 5.28 million run rate compares to a 4.9 million unit rate in 2008, 5.2 million units in 2009, and an all-time high of over 7 million units.


Employment/Wage Report Is All That Matters in a Sea of Data This Week

There is a lot of data coming in the week ahead, but my key focus will be on the employment report due Friday. Spending ran ahead of incomes in the fourth quarter, a situation that is not sustainable over the long term. Given that compensation represents almost two thirds of consumer income (dividends and interest, rents, small business income, and government transfer payment comprise the rest), I need to start seeing an increase in total compensation. This increase can come from some combination of improved real hourly wages, weekly hours worked, and number of people employed. All of this is contained in Friday's employment report. The consensus is for job growth of 150,000 compared to December's disappointing 103,000 level and a 0.2% jump in hourly wages. Both those numbers seem easily attainable based on regional purchasing managers' reports and reduced initial unemployment claims over the last several months.


Manufacturing Sector Should Show Continued Improvement

Based on those same regional purchasing managers' reports on manufacturing, I suspect that the national purchasing managers' survey will show a tiny increase from December's 58.5 level. On the manufacturing front, I also suspect auto sales may be up again in January after a stellar December. While it is nice to see that manufacturing didn't execute the double dip that many feared this summer, manufacturing data aren't all that important at this part of the cycle compared to news on the consumer and inflation.



This is an edited version. The article originated from Robert Johnson’s column at

Facebook Twitter LinkedIn

About Author

Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

© Copyright 2024 Morningstar Asia Ltd. All rights reserved.

Terms of Use        Privacy Policy        Disclosures