A Negative 2% GDP in the Third Quarter?

From John Mauldin’s hedge fund newsletter:

“And now let me introduce you to a new economic metric from the Consumer Metrics Institute. They track consumer discretionary spending on a daily basis. ( http://www.consumerindexes.com/index.html – hat tip Bill King.) From their web site:

“The Consumer Metrics Institute was founded on a simple observation: many ‘leading’ economic indicators are published, but few (if any) are sufficiently ‘leading’ to be meaningful to investors. In fact, many ‘leading’ indicators use the prior month’s equity market results as a key component of their indexes. Investors may find their most recent month-end account statements more timely.

“To remedy this, the Consumer Metrics Institute has developed (and is continuing to develop) techniques for monitoring ‘up-stream’ economic activities on a daily basis. The daily consumer sampling process commenced in 2004, and several years of data were required to refine the process and statistically analyze how the timing of our indexes related to other ‘leading’ indicators, including the equity markets. The 2008-2009 recession provided a final validation of the methodologies and confirmed a multi-month lead relative to other commonly referenced indicators.”

Their Consumer Metrics Institute Growth Index, which is the composite of a number of sub-indices, seems to lead GDP growth by about 4-5 months. Look at this chart showing the index and GDP growth for the past four years.”

Consumer Metric Ins. Daily Growth vs BEA's Quart. GDP


“On May 27th the BEA released its first revision to its 1st Quarter 2010 GDP growth rate measurement, lowering the number from a 3.2% annualized growth rate to 3.0% annualized growth. One day later the Consumer Metrics Institute’s ‘Daily Growth Index’ was signaling what we should expect the BEA’s measurement of the 3rd Quarter 2010 GDP growth rate to be contracting at about a 2.0% rate.

“The prior BEA estimate of 1st Quarter 2010 GDP growth trailed our ‘Daily Growth Index’ by 127 days, and because of the rapid rate that the economy was cooling when the measurements were being made the newly adjusted estimate is now trailing our ‘Daily Growth Index’ by 125 days. Since the 3rd Quarter of 2010 ends 125 days after May 28th (when our ‘Daily Growth Index’ was recording a ‘growth’ rate of -1.99%), if the BEA estimates continue to trail our ‘Daily Growth Index’ in a consistent manner we should expect that the 3rd Quarter’s GDP ‘growth’ rate will be in the -2.0% neighborhood.”

Wow. A negative 2% in the quarter starting next month? How can that be? Let’s look at what caused the recent growth.

First-quarter GDP was revised down to 3% last week by the BEA (Bureau of Economic Analysis). But buried in that release was an upward revision to inventories, which accounted for over half of that 3%. At some point inventories become balanced and no longer grow.

And that may already be happening. We got the ISM number on Wednesday, and it came in somewhat above consensus at a quite robust 59.7. But when you look at the inventory sub-component, you find a different picture. It was slightly negative in April and dropped another 3.8 in May to be down to 45.6. This is a drop in that index of 9.7 points in just two months (anything north of 50 shows growth and below 50 suggests no growth or actual retreat).

Increases in inventory count as a plus when you are figuring GDP. If inventories are not growing, that figures to be a drag on second-quarter GDP.

And a significant part of the growth in the past three quarters came from transfer payments from the government (AKA stimulus), which are going away. The money received by state and local governments, which allowed them to keep employees on the job, is now being taken off the table; and the stories of state and local governments having to cut back are everywhere.”