Guest Post: 3Q GDP Weaker Than Expected

Tyler Durden's picture

Submitted by Lance Roberts of StreetTalkLive

3Q GDP Weaker Than Expected

gdp-3q-2011-revisions-122211"... let me just provide you with a quick reminder that the first estimate of GDP released by the Bureau of Economic Analysis is tied closely to the consensus estimate of economists as there is incomplete information about the various subcomponents to make a more accurate estimate.  Therefore, it should really come as no big surprise given the shocks that hit the economy from the debt downgrade, political infighting over the debt ceiling and the Eurozone crisis that the release was EXACTLY in line with the consensus estimate of 2.5% growth yesterday.  The reason I point this out is that it is VERY rare that the consensus is EVER spot on to the first decimal point with the release.   I find this very suspect."

That is our quote from our review of the initial 3rd quarter GDP release on October 28th.   I also got chastised quite a bit on our analysis that Personal Consumption Expenditures were highly suspect with most of the money spent on Medical Bills and Utilities due to the summer heat wave.   However, with today's release of the final revision of 3rd quarter GDP we find GDP not growing at 2.5% as per the original estimate, or even 2% from the second revision, but a meager 1.8% when the data finally all poured in.   I suggest that you review our original post for context .

gdp-recession-indicator-122211Recession Coming?

There has been a large debate as of late about the economy going into 2012.  Will it "muddle through" at a sub -2% rate, rebound sharply to more than 3% as currently estimated, or will we decline into a secondary recession?   Cases can clearly be made for all three scenarios and only time will tell who is correct.  However, this debate entirely misses the essence of what we are most concerned about - our investment portfolios and the risks to those investments from economic pressures.

I have clearly made the case in past missives about the potential for a recession in 2012.   When real GDP has declined below 2% growth on a year over year basis the economy has normally been, or was about to be, in a recession.   With today's downward revision to Q3 GDP we have now had two consecutive quarters of sub-2% GDP growth.  There are only two instances in history (Q3-1956 and Q1-2007) where there were two consecutive quarters of sub-2% GDP annual growth and the economy wasn't already in a recession. 

gdp-recession-table-122211In 1956 the economy rebounded for one quarter to 2.93% annual growth in Q4, slipped to 1.88% in Q1 of 1957, rebounded once again to 2.99% growth in Q2 1957 as the recession officially started.   The other was in Q1 and Q2 of 2007 and we all know how that worked out in next couple of quarters.  These are the only instances where the economy "muddled"  along for a period of time before way to the recession.  The reality is that an economy cannot muddle along - it will either grow or contract.  "Muddling" isn't historically an option.

It is important to remind you that a bounce in economic growth, as we will likely see in the coming Q4 GDP analysis beginning in January, does NOT in any way offset the probability of recession.   As we stated during our initial analysis of Q3 GDP it is not uncommon for GDP to tick up just prior to a recession.  In fact, in almost every instance, as shown in the table, the economy has had a positive growth rate, and in some cases a very strong growth rate, just prior to recession.  

My point here is that looking at quarter over quarter numbers, particularly when they are presented at an annual rate, is very misleading.   As always it is the trend of the numbers which is much more important in determining future outcomes.  This is why we look for historical tendencies for future outcomes and in this particular case we note that sub-2% growth rates have always occurred just prior to or in a recession.

gdp-gdi-122211However, there are two other ways that we look at economic activity other than just GDP.   The first is GDI - Gross Domestic Income.   As my friend David Rosenberg pointed out in his missive today "In real terms, as the bars illustrate, growth has almost stagnated over the past two quarters - +0.2% and +0.4% at an annual rate, the weakest back-to-back performance since the recession ended in mid-2009.  The YoY trend line depicts a decisive pattern here: from the third quarter of 2010 to this past third quarter - 4.3%, 3.5%, 2.6%, 1.7% and now 1.1%.  That is a trend, indeed - a downtrend in real national income."

Declines in Gross National Income typically lead recessionary spats in the economy.  The one saving grace at the moment for the consumer has been a decline in gasoline prices in the 3rd and 4th quarters which have given consumers about a $70 billion boost to bottom line discretionary income that they aren't spending at the pump.  There are two potential issues coming that could reverse that: 1) the inaction of Congress to extend the payroll tax cut will see tax home pay drop beginning in January and 2) any rise in gasoline prices with personal savings rate already at very low levels.  

gdp-outputgap-122211The second way to look at economic activity is to explore the "output gap" which is simply the difference between the economy operating at full capacity and the level of actual economic activity.  Currently that gap was only this wide during the back to back recessions of early 80's.  

The real pressure on the economy, and why a "muddle through" scenario is unlikely to be sustainable is the gap between aggregate supply and demand while will continue to compound economic pressures overtime.  In turn this will continue to depress final demand by consumers which will keep pressures on wages, hiring and production.  If we want to get a clear picture of this impact on the actual production side of the economy we can look at our composite economic index.   

The Streettalk Economic Output Index is a composite of the major Fed regional manufacturing surveys, leading economic indicators, the broad Chicago Fed National Activity Index, the NFIB small business survey and a composite ISM index.   This index is extremely broad in scope to get a better understanding of what is actually happening in the underlying economy.   We have then smoothed the index with a 6-month average to reduce noise from monthly volatility in the underlying components.   Historically when this index has declined below 35 the economy has either been, or was about to be, in a recession.  

sta-composite-economic-122211Currently the index is at 30.49. 

Why Is This Important?

Could we somehow avoid a recession in 2012?   Quite possibly.   Will it matter?  Probably not. 

Let's go back to our original premise.  We are all wanting to make the correct assumptions going into 2012 as it will directly relate to the performance of our investments.  However, our job is to understand the "odds" of success at any given time - that is basic portfolio risk management.   

Whether the economy is technically or statistically in a recession in 2012 is largely going to be irrelevant.  The reality is that if we look into the final release of Q3 GDP we see weakness in not only incomes but also a much weaker consumption component than what was originally reported.  With estimates for corporate earnings at very lofty levels currently going into 2012 - any impact to profitability due to a weaker economic environment, higher oil prices or weaker incomes is going to negatively impact the stock market and our portfolios.

The economy is currently clearly under stress.  The potential for an impact from a recession in the Eurozone, which makes up 20% of exports and profits for U.S. companies, is high.   China is clearly slowing down as they are highly dependent on the U.S. and Europe for their export based economy.  We have consistently witnessed a negative export gap over recent months which further supports this case.  Finally, we are seeing a consistent roll of negative guidance on a 4-1 basis from companies guiding down expectations and earnings as witnessed by recent misses from Oracle and others.

My point is this.   It is long time to do away with "bullish vs. bearish" mentality.  This labeling is only relevant to an emotional bias which has no place in your investing process.  What we need to focus on are the facts behind the continually optomisitc mainstream media headlines.

The recent improvement in the month over month data is encouraging, however, it has done little to reverse longer term trends.  The underlying weakness in the overall economy is pervasive and persistent and it will take a couple of more quarters to tell if the danger has passed.  What is ultimately the case is that as investors we will have more than enough time to adjust portfolio risk levels to capture improvement when it comes.  However, betting against the trend of the data can be dangerous as recessions can come quickly with a devastating impact to portfolios.  A missed opportunity in the markets can always be regained - recovery of lost principal is an entirely different matter.

Personally, I sincerely hope that the economy continues to improve - but "hope" is not an investment strategy that we employ.

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Irish66's picture

Doesn't Corzine and Paulson performance look suspicious?  Both need a real explanation

economics1996's picture

The whole GDP formula is BS.  It should read Y+C+I-G+NX.  The whole idea that government contributes to the GDP is a fucking joke.  We have been in a recession/depression since 2007.  My next blog will look at where the real GDP is.

Here is one of my old ones on the subject.


How do you measure bull shit?

bob_dabolina's picture

Did Occupy Wall Street file a 501 3c?

What ever happened to all that donated money?

Long-John-Silver's picture

The money was returned to the Obama campaign coffers.

bob_dabolina's picture

I guess the organizers didn't want to pay their "fair share"

slewie the pi-rat's picture

abandon all hope, ye who enter here

we are freaking D00MED, BiCheZ!  L0L!!!

ucsbcanuck's picture

Now now slewie, how many times have we told you to take your meds so that you do not frighten people away :-)

Long-John-Silver's picture

We are in a Depression. There will be ups and downs because no one will admit that we were in a depression until it's over. We are about to have another dip they will call a recession. Then there will be a slight recovery followed by another downturn. At some point the politicians will start a wide ranging war in an effort to end the spiralling economy.

economics1996's picture

Or the world will decide its time for civil war.

midtowng's picture

True. We are in long-term decline. No doubt about it.

However, Q4 will NOT be a recessionary quarter. You can count on that.

blu's picture

A wide ranging war will not end this [rec|depr]ession. It will only manage to burn through the last oil reserves and collapse the globally intertwined economic ecosystem. Those nations already in a birth decline will lose even more young men, who will take their ideas and creative energy into the grave. There will be no "last superpower standing" because not even the US will be able to function at that level without copious flowing oil and a vital work force of skilled and able workers.

We should be marshalling our declining resources for the needed transition into a sustainable low-growth economy having a real honest-to-God domestic GDP and not this faux GDP based on how well Goldman can rape the developing world. Didn't work for Spain in the 1500's not going to work for us either.

We either tackle all the systemic problems and win the future, or we skate along waiting for a miracle and so lose it.

We'll skate. Because it's the easier route, we'll do nothing. War will come and go and we'll be left standing among the blackened ruins of 800 years of Western civilization looking around in slack-jawed horror and marvelling at the astounding miscalculations we made at the end.

Shizzmoney's picture

Good stuff, here.

Could we somehow avoid a recession in 2012?   Quite possibly.   Will it matter?  Probably not. 

My point exactly.  The Patriots Defense is the worst in the league, however they'll still make the playoffs; but when it comes to "nut-cutting" time - it will cost them in the end.  And everyone knows it (but won't state the obvious b/c Pats have Tom Brady).

blu's picture

We're going to put the both of you in the same padded cell.

Snakeeyes's picture

The press is going gaga over the GDP report and jobless claims. I wsa called by Bloomberg News and said that Euro GDP is hardly a reason to celebrate and PCI was worse than expected. But alas.

FritoPendejo's picture

The press is in the tank for Obama. No bad news connected to him will be reported from now until election day. It's all about re-election, baby.

RobotTrader's picture

XRT and RTH:  One of the biggest 3-year runs in history


Meanwhile, the world did not end and PM's and PM shares were decimated in 2011.

Gasoline prices are on the decline and natural gas prices are pressing towards world record lows.

Lots of "experts" and "pundits" got it 100% wrong.

Tsar Pointless's picture

You are one delusional Robot.

I offer you to trade places with me. You can see what it will be like to be a two-person, one-UC-benefits-income family in two weeks' time and I can sit around in your mom's basement fondling her while eating Cheezy-Puffs.

lieutenantjohnchard's picture

i guess you would know about said decimation given your ira full of gold stocks as you've told (lied) us before. and you sure aren't shy about reminding us (lying) you bought a monster box of silver for $5.00 per copy several years ago.

robottrader: the eunuch of trading.

RobotTrader's picture

Sorry about your horrific losses in names like TRX, UXG, etc.

Yes, I have one IRA account with gold stocks, but it is small.  My biggest account is stacked up with dividend paying stocks which have done great this year.  Biggest holding is MO.

Yes, I still have my monster boxes and plenty of gold bullion, but I don't trade or leverage those like so many CIGA and GATA monkeys who get constantly wiped out by the PigMen speculating with paper futures like Celente.

Good luck to you in 2012.

Mr_Wonderful's picture

Yeah Mr. Robot, and the price of U.S. govt debt is slightly off a 200-year high. The death of the dollar remains ever elusive, along with hyperinflation. Meanwhile the supendous tsunami of technological advances, productivity increases and dirt cheap labor keeps rising. These are extremely strong and dangerous deflationary forces which require extreme measures. Prices must go down radically, debt must be written off and wages and taxes must be cut. Debt bubbles are bursting and cash is being hoarded in anticipation of falling prices, which is a rational marketplace reaction but the govt. and the FED remain aloof. This has to change and they must participate in the ongoing correction.

acompletedouche's picture

The worse the news,the more they goose this POS up.Anyone see ES on the final tick?With one second to go we went up 2 full ES points.These games are just silly and will lead to disaster.

AS for volume?It sucked ......QQQ was half of the normal volume.

Snakeeyes's picture

There will be revisions to Q3 GDP because of the NAR existing home sales revision. Again, this recession is FAR WORSE THAN THEY ARE SAYING!

NAR's Existing Home Sales Revision of 3 Million Sales Over Past 5 Years - Mostly in the Northeast, Less in the West - GDP Revision Coming!

Piranhanoia's picture

Doesn't the irony bite itself?   These guest posters are likely sage and savvy folks. They seem loathe to mention that the real economy has no stabeeleetee or growth and all fundies are trashed.  The 1.8% figure has no reality.  There is negative growth or recession.  Yet most will tell you how to raise your profits in this dire evironment.  Most won't mention anything about trying to Save Your Ass as the world churns.  Thus, always a positive spin to something that doesn't deserve it.

doesn't make sense to me to ignore world collapse or that crime is now brags about running the whole world.

FritoPendejo's picture

The press is spinning the news because it's all about re-electing Obama right now.

blu's picture

However, this debate entirely misses the essence of what we are most concerned about - our investment portfolios and the risks to those investments from economic pressures.

Okay I understand the guy is immersed in portfolio management, but how stupid and narrow-minded is that statement? It really shocked me to see that. Talk about the entire planet sliding into recession and depression and the world financial system going up in flames and that's the best you got? Your investments? Nothing about the rise of a new Facsism or pan-global mechanized warfare? That's just the kind of me-first rip-your-face-off thinking what got us into this mess in the first place.

Fine then let it burn. Pig fat fries up nice and crispy. Be seeing you and your investments at the bonfire.



Caviar Emptor's picture

Yup. The mindset is still that this is all just a detour and what matters is the paper economy (including people's paper profits from 'inwestments"). Meanwhile Rome burns and they consider that a side-show. They're making mistakes of historical proportions that will be looked back on with scorn

Spacemoose's picture

posted earlier but more on point here, with respect to my assertion that GDP must fall before our standard of living can improve.

with respect to productivity, i have two axioms.

1. in the long run (and absent war or theft), the value of the goods and services which country "X" can distribute to its citizens, must be equal to the value of the goods and services which the citizens of country "X" produce (a sentiment which, for unknown reasons, is rarely articulated here except with respect to greece and then only in a roundabout way ["nobody works there"]. is it too obvious to be stated?).

2. in the short run, the value of the goods and services which can be distributed to the citizens of country "X", must be equal to: the value of the goods and services which the citizens of that country produce plus the value of the goods and services the citizens of another country are willing to lend to country "X", less the value of goods and services country "X" transfers to other countries, either as a loan from country "X" or as payment of principal and interest due from country "X" to other countries.

thus, for most of us here in the real world trenches, what really matters is not, per se, bond sales, interest rates or deficits, but rather, the impact those sales, rates and deficits have on productivity and on the allocation of the yields of that productivity.

if you adhere to the above axioms, then even a cursory examination of the numbers would tend to indicate that, if we continue our present path, the US must, at some point in the future, experience (at minimum) an approximate 11% decrease in its standard of living. worse yet, insofar as our GDP includes "goods and services" produced by the government, the actual percentage decline measured against "real" goods and services will be greater, due to the fact that the great majority of "goods and services" produced by the government are the GDP equivalent of empty calories. our situation is certainly not helped by the fact that federal, state and local spending may constitute as much as 40% of GDP. add on top of that, the percentage of GDP which is derived from the FIRE sector is over 20% which (although having some production facilitation and capital formation benefits) is also largely empty calories.

paradoxically, if the above is true, then an increase in the average standard of living of a typical american can go up if GDP goes down. as an example, assume the example of an employee of the dept of energy who is employed for $100,000 per year, writing oil company regulations (which increase the expense of producing energy). in an effort to decrease government regulations, that employee is laid off (this is just hypothetical. we all know that no such thing would ever happen). the ex-gov employee then goes to work for an oil company, for a salary of $50,000 per year. what is the effect on the economy? the standard of living of the ex-gov employee declines by $50,000. the standard of living of the taxpayers who were supporting the ex-gov employee increases by $100,000. the employee increases the productivity of the oil company by an unknown amount Y and the oil company, free from some regulation, increases productivity by X amount, also raising the standard of living of all of us (in the form of cheaper energy for instance). thus, the net increase in the american standard of living has increased by $50,000 plus the value of whatever net increases the additional employee adds to the productivity of the company. the absence of regulations also adds to the productivity of the oil company thus increasing our standard of living. (this would be net of any decrease to our standard of living caused by the absence of the regulations. however, i am assuming, perhaps incorrectly, that the 75,000 pages of rules and regulations in the federal register are a net drag on our average standard of living). thus, GDP down, but standard of living up. (multiply this effect by at least some portion of the over 22 million people who work for federal, state and local governments, and pretty soon we're talking about a real difference in our standard of living).

note that at the beginning of the preceding paragraph, i said "an increase in the average standard of living of a typical american can go up if GDP goes down". i'm not certain that's wholly accurate. it may be that we have gone so far down the road in putting our human assets in non-productive work (like community outreach coordinators for instance), that an increase in the average standard of living of a typical american can go up ONLY IF GDP GOES DOWN.

some might argue that a community outreach coordinator working for $100,000 per year could easily increase the standard of living in a poor community by an amount greater than $100,000 per year. this is undoubtedly true. however, in most situations this is done by decreasing the standard of living of taxpayers by an amount greater than the benefit given to the community. no new goods and services are created in such an endeavor and the net is an overall decrease in the average standard of living in an amount equal to (at least) the salary of the coordinator.

there are only two ways out as i see it. either increase real productivity (i.e. production of goods and services people really want, as opposed to midnight basketball programs for disadvantaged youth) or reduce consumption. look as i may, none of the statements of our rulers imply that they understand this in the least and a neutral observer might go so far as to say that the current administration is actually trying to supress productivity. it's like they are obsessed with treating the symptoms and not the underlying cause. is the problem that difficult to understand?

the problem is not the deficit, the deficit is a symptom. the problem is not debt burden, the debt is a symptom. the problem cannot be solved by printing or by not printing. it cannot be solved by tweaking the rates. as i see it, the problem is that WE ARE CONSUMING MORE THAN WE PRODUCE, AND WE HAVE OBLIGATIONS COMING DUE IN THE FUTURE, WHICH WILL RESULT IN AN EVEN GREATER GAP BETWEEN CONSUMPTION AND PRODUCTION. what part of that do you not understand, ass hat leaders? this is the fundamental economic problem facing the country and it is rarely expressed as such, in the discourse. why is that? is it because stating the problem in this way also defines the solution and the solution is something that cuts against the power and wealth of too many of TPTB? or is it that we believe there exists some alternate dimension solution which would allow us to retain a "business as usual" lifestyle and still pay ever increasing monetary tribute to the government and its private industry enablers? i think not.

now, obviously, there is a "sweet spot" with respect to how much government services and wealth redistribution society needs for efficient functioning not to mention the moral component of not allowing our fellow fellow citizens to die of starvation. however, the fact that today we have more government employees than manufacturing employees certainly implies that not only have we traveled past that "sweet spot", we've thelma and louised ourselves right off the edge of an economic cliff. if we are to stop what appears to be an inexorable slide into third world status we are going to need an attitude shift among our leaders. they immediately need to recognize that productivity is a greater virtue than charity.

thus, reductions in FIRE and government payrolls, although resulting in a nominal decrease in GDP, could actually result in an increased standard of living in the long run as allocation of human resources are shifted away from non productive activity and towards production. why is there so little analysis along this line of thought?

Caviar Emptor's picture

why is there so little analysis along this line of thought?

They're paid not to think and not to fix anything at all

Georgesblog's picture

I doubt that there is any growth. In fact, I doubt that there has been any growth since 2007. I'd like to see GDP numbers adjusted by deducting total debt service and trade imbalance from the raw GDP numbers. I'm sure that comes out far short of anything that can be spun, as good news.

Mr_Wonderful's picture

WTF happened to that Apple vs. Android post from Mr. Middleton? It had some good and informative stuff and then it suddenly evaporated.

RiverRoad's picture

Right.  There's no "muddling" going on; it's whistling past the graveyard pure and simple.

Mike in GA's picture

I'm sorry, sir, we just do not "do" downsize in this economy. 

We do supersize, oversize, rightsize, terrorize, thunderthighs, capsize and euthanize.

We politicize, excise, enterprise, freedom-fries, livin lies, Mama sighs. It's TEOTHWAWKI....

*Any recently downsized personnel will report to the S. Green FEMA holding area prior to the next unemployment reporting period. :) :):)

response to Caviar above