This month’s headlines signaled news that real U.S. gross domestic product (GDP) for the first quarter of 2014 was revised downward substantially. From an advance release showing sluggish growth of 0.1 percent annually, the final estimate released in June juked down to a 2.9 percent contraction in annual GDP.
Much of the decline was likely related to the extreme conditions of this past winter’s polar vortex, which dropped most of the U.S. into a deep freeze. Markets generally reacted placidly to the revision, suggesting that the impact was at least somewhat anticipated and baked into market expectations. For a number of reasons, we don’t usually look at GDP as a primary indicator of business cycle conditions, and the latest news does not alter our outlook for the economy in the U.S. We take the downward revision as consistent with the impending slowdown of growth in the U.S. economy that we’ve forecast for this year, rather than the onset of recession.
There are a couple of things worth noting about this GDP development, however. Firstly, even though the drop in GDP appears attributable to the polar vortex rather than directly to long-term economic factors, the fact that winter weather-related phenomena could have such a sharp effect on a highly developed economy such as ours could be a sign of the potential economic headwinds that we’ve noted in previous issues.
Institutional malaise in the form of a burdensome national debt, consumers pinched by a rising cost of living, and increasingly rigid financial regulation could tend to decrease the resilience of our economy and heighten its sensitivity to real shocks like extreme weather events. The more inflexible an economy, the greater the risk that something like a deviant polar vortex could end up being the snowflake that breaks the camel’s back.
Second, the drastic revision underscores the weakness of tracking GDP as an indicator for strategic management and business planning. Although it might be useful for retrospectively dating the onset of recessions or describing historical trends, as a quarterly series subject to frequent, drastic revisions, GDP is useless as a leading (or in many cases even coincident) indicator for most businesses and industries.
In particular, a large body of economic research has shown that GDP becomes more volatile, and subject to the largest revisions, during recessions and at major economic turning points—precisely when you need the clearest picture to make pivotal decisions for your business. This effect tends to distort economic policy making and business planning during critical times. Overextending yourself at the moment of crisis or missing opportunities to maximize gains by investing early into an economic boom can be critical missteps.
A single aggregate like GDP makes headlines, but it isn’t of much everyday practical value without an understanding of how business cycle conditions specifically relate to your company and your customers. Understanding the causal links and timing relationships between different sectors of the economy, industries and economic indicators is crucial. It really takes a comprehensive look at a variety of less highly aggregated indicators, preferably published at least monthly, to tease out patterns of cyclical change in the complex tapestry of the economy.
On that note, our analysis of U.S. industrial production and leading indicators shows continued growth this year, regardless of the confusion over first-quarter GDP. The recovery in the U.S. is broad-based: The Federal Reserve’s Beige Book shows growth in all 12 Fed Districts; 17 of 18 industries surveyed for the May ISM Purchasing Managers Index reported expansion; the U.S. leading indicator trend remains positive, and consumer expectations are on the rise.
Total retail sales (inflation-adjusted) rose 3.8 percent in the past 12 months to a record high $2.7 trillion. The internal signals indicate spending growth will slow this year. Auto production (at an 11-year high) and auto sales (six-year high) remain positive.
Annual non-defense capital goods new orders (business-to-business activity) rose a healthy 5.0 percent in the year to April, but there has been a noticeable decline in the quarterly rate of change, a signal that growth will slow. The good news is that we are seeing positive momentum in non-defense and defense communications new orders.
In the manufacturing sector, annual industrial machinery new orders reached a new record high at $50.8 billion, and annual industrial machinery production is 9.0 percent higher than last year. Downstream industries, such as wood products, pulp and paper products, rubber and plastic products, and semiconductors and related equipment are all slowing, signaling that industrial machinery production will moderate as demand for processing equipment slows. Favorable energy costs, proximity to final consumer markets, and an increase in foreign direct investment into the U.S. are all contributing factors in the growth in domestic manufacturing over the past 12 months.
At the same time, the rising cost of living and the slowdown in housing starts point to more moderate growth late in the year and heading into 2015. The accelerated rise in housing starts ended a year ago, and the rate of ascent has markedly slowed. Weather might not have helped, but the easing in starts began as affordability declined.
Our advice is not to pay much attention to the negative news about the first-quarter GDP data. Growth continues at a steady, though mild, pace. Competition is always in pursuit. New regulations are squeezing margins in many sectors. Innovation of new or existing products and improved services will be crucial to retaining customers and increasing market share. Hire key people now that will move your company forward. Be prepared for wages, inflation and healthcare costs to press cash flow in late 2015.