Comstock Partners, Inc.January 30, 2014
Don't Be Misled By 4th Quarter GDP Growth
The headlines touting 4th quarter GDP results as giving rise to a new breakout in economic growth are highly misleading. The 3.2% rise in 4th quarter GDP as well as the 3rd quarter increase of 4.1% is unsustainable, and it is likely that the peak for the GDP in the current cycle has already been made.
Final domestic demand growth (GDP less inventories and foreign trade) were up a tepid 2.3% in the 3rd quarter and only 1.4% in the 3rd. Together, the increased inventories and foreign trade were responsible for 1.7% of the 3.2% climb in GDP. In addition, the 3.3% rise in consumer spending was largely accounted for by a lower household savings rate rather than an increase of income. Real disposable income for the quarter was up only 0.8%.
The so-called resurgence of consumer spending is not soundly based since it does not reflect a commensurate rise of income. For example, in the 4th quarter consumers increased their spending by $89 billion, but accomplished this only by reducing savings $72 billion. Therefore 81% of the spending increase was fueled by reduced savings. Given the underlying factors behind 4th quarter GDP growth, it is highly likely that the 1st quarter will reflect lower growth in consumer spending, inventories and foreign trade that accounted for a combined 4% of the 3.2% growth in 4th quarter GDP.
All of the above should be evaluated against the longer-term background of the consumer balance sheet recession that we have mentioned in numerous past comments. While a lot of progress has been made in reducing household debt, there is still a long way to go. At its 2007 peak, the ratio of household debt to disposable income was 130% and has now been reduced to 104%. However, the long-term average ratio was about 76% during a period when consumer spending was far more robust than it is today.
The latest figures indicate annualized disposable income of $12.6 trillion and household debt of $13.1 trillion. In order for debt to be back down to its more normal level of say 80% of DPI, it would have to drop by about $2.6 trillion, an amount that is 23% of consumer spending. Since this obviously won’t happen all at once, the process will be drawn out over a number of years and put constant downward pressure on consumer spending for a long time to come. That is what usually happens after a severe credit crisis, and that is what has been happening over the last few years. And, since consumer spending accounts for about 70% of GDP, overall economic growth is likely to remain below average as well.
Despite the tepid growth of the last few years, the market has rebounded strongly, propped up by massive monetary easing in the form of near-zero interest rates and a huge expansion in the Fed’s balance sheet as well as by increased corporate income. Now, however, these positives are receding as the Fed intends to eliminate quantitative easing by year-end, and the ability of corporations to increase profit margins in the absence of adequate revenue growth is rapidly diminishing. At the same time the withdrawal of quantitative easing is having unintended negative consequences on a number of emerging market economies while stock market valuations are stretched on the high side and sentiment is more bullish than at any time in the last 25 years. In our view, a major market decline is likely in the period ahead, and may already have started.