3Q2014 Gross Domestic Product: Second (Preliminary) Estimate

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According to the Bureau of Economic Analysis’ (BEA) “preliminary” estimate, 3Q2014 growth in real U.S. gross domestic product (GDP) was upwardly revised to a seasonally adjusted and annualized rate of 3.9% -- up roughly 0.4 percentage point above the first (“advance”) 3Q estimate but 0.7% below 2Q’s 4.6%. This revision “slammed” expectations of a decline to 3.3% (ranging from +2.8 to 3.8%). All four categories -- personal consumption expenditures (PCE), private domestic investment (PDI), net exports (NetX), and government consumption expenditures (GCE) -- contributed to 2Q growth.

The categorical contributions to the headline number bear little resemblance to last month’s report. For example:

-- The significant inventory draw-down reported a month ago almost vanished (dropping to a mere -0.12% impact on the headline number, compared to -0.57% last month).

-- Improving fixed investments added +0.23% to the headline (from +0.74 to 0.97%), with nearly all of that improvement from spending for commercial equipment.

-- Consumer spending for goods was also reported to be growing by an additional +0.27% in this report (from +0.70 to 0.97%), while consumer spending for services was essentially unchanged (+0.02%).

-- Finally, while exports were revised modestly lower (from +1.03 to 0.65%), a small decline in imports (from +0.29 to 0.12%) partially offset the net decline in trade’s contribution.

For this report the BEA bumped up its estimate of annualized net aggregate inflation (to 1.40% instead of the “advance” report’s 1.28%). By comparison, the growth rate of the Bureau of Labor Statistics’ concurrent seasonally adjusted CPI-U index was -0.10% (annualized); meanwhile, the price index reported by the Billion Prices Project (BPP) was -0.18%. Were the BEA’s nominal estimates corrected for inflation using the CPI-U, real 3Q GDP would have grown by 5.42%; if using the BPP inflation rate, growth would have been 5.52%.

Growth in real final sales of domestic product, the BEA’s “bottom line” indicator of economic health (which excludes the ever-volatile inventories) was shaved to 4.1% (from 4.2% last month). 

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Conclusions from this report include:

-- As mentioned last month, the Federal Reserve’s argument for completing its QE taper was strengthened. An economy growing at 3.9% is presumably healthy enough to be “weaned” off central bank stimulus.

-- Rapidly changing dollar-based commodity prices (and more specifically energy prices) are likely playing havoc with both the BEA’s inventory and net import/export data, both of which changed materially in this revision. While one might expect inventories to be valued exclusively using some variation of book-value FIFO accounting logic, they are in fact additionally impacted by an “inventory valuation adjustment” (or “IVA”) that utilizes price changes from a “Fisher formula” (that according to the BEA’s notes “incorporates weights from two adjacent quarters; quarterly indexes are adjusted for consistency to the annual indexes before percent changes are calculated”) when converting inventory values from “nominal” to “real.” For this reason, rapidly changing dollar-based price levels can cause “real” inventories and net import/export data to fluctuate even if physical quantities remain relatively constant -- providing temporary “noise” that duly reverses in subsequent quarters.

-- From a global perspective, this reported growth is extraordinary. Again at face value, this report shows an economy isolated (if not benefiting through falling dollar-based commodity prices) from softening global economies.

-- That said, consumers are not spending as if the U.S. economy is healthy and sustainable. Consumers generated well less than half of the headline growth even though they are still over two-thirds of the economy. And half of the previously reported growth in real per-capita disposable income vanished in this revision -- explaining to some extent why consumers have remained wary.

The foregoing comments represent the general economic views and analysis of Delphi Advisors, and are provided solely for the purpose of information, instruction and discourse. They do not constitute a solicitation or recommendation regarding any investment.