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Economy in Brief

Q1 GDP-- Something Odd in the Numbers
by Joseph G. Carson ([email protected])  April 29, 2019

The Bureau of Economic Analysis (BEA) estimated that Q1 real GDP rose 3.2% annualized, advancing almost a full percentage point above the consensus estimate of 2.3%. The headline gain in real GDP proved to be a big surprise, but the composition of the gain was even more so.

According to the initial Q1 GDP data, the 3.2% gain consisted of a 6.5% gain in GDP goods, a 1.8% increase in services, and a 2.2% uptick in structures. The relatively large gain in GDP goods output is the outlier and deserves further examination.

GDP goods is a measure of domestic output and it includes all of the valued added from production through the distribution channels and also the items that end up in inventory. BEA uses a variety of source data to measures goods output since it includes final sales to consumers, businesses, government and foreign customers along with changes in inventory investment at the manufacturing, wholesale and retail levels.

In Q1, the 6.5% gain in goods output was comprised of 4.5% gain in real final sales and an increase of $32 billion in the rate of inventory investment, lifting the quarterly build in inventories to $128 billion, the largest quarterly level in four years.

What is odd about the large gain in GDP goods is that domestic production, as measured by the Federal Reserve Board, contracted 1.6% annualized in Q1, led by a large decline in motor vehicle output.

So the key question is how can final sales of goods rise and businesses add to overall inventory positions if there is no growth in the output of goods? The answer is that all of the real output growth occurred in the markup of valued added through the distribution channels with a big boost coming from falling prices.

BEA estimates that GDP goods prices contracted 0.6% in Q1, which means that nominal output of goods rose less fast than real output.

None of this is meant to imply that the Q1 GDP figures are wrong. BEA uses a variety of data sources and has much more information at their disposal to generate the GDP stats.

Yet, what the underlying data does show is that the headline output gains are not as impressive at they appear to be on the surface and that the decline in goods prices indicates companies are losing money on inventories, while also experiencing margin pressure as labor costs are rising above price and sales gains.

Although operating profits are not officially measured in the initial release on GDP one can guesstimate it based on the available data. According to the GDP data operating profits declined in Q1 relative to Q4 and that follows a small decline in Q4 over Q3. Overall profit levels are still relatively high but no longer advancing due to sluggish sales growth and rising costs. Thus, all of the gain in the equity market since the start reflects a relatively large increase in the market multiple.

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