New Study Cites Big Errors In Government GDP Numbers
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 29, 2016
IN THIS ISSUE:
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
1. US GDP Rose 1.4% in 4Q; Sub-2% For All of 2015
2. 2015 Corporate Profits Fell by Most Since 2008
3. Should We Trust the Government GDP Numbers?
4. Celebrating 30 Years of Marriage to My Best Friend
Government GDP Numbers – Overview
We start today by looking at last Friday’s third and final 4Q GDP estimate. While the headline GDP number was slightly better than expected, corporate profits fell off a cliff in the 4Q.
Next, we’ll look at a new report from CNBC which reveals that the Commerce Department’s estimates of GDP are well off the mark most of the time. This will surprise you.
Finally, Debi and I celebrated 30 years of marriage on Easter weekend. She and I met in the workplace in 1982 and became best friends before long. In 1984, the friendship turned romantic and we married in 1986. We’ve remained best friends and business partners ever since. There’s a new photo of us at the end of today’s E-Letter.
US GDP Rose 1.4% in 4Q; Sub-2% For All of 2015
While the markets were closed on Good Friday, the Commerce Department reported that 4Q GDP rose at an annual rate of 1.4%, which beat the pre-report consensus of 1.0%. This was the Commerce Department’s third and final estimate of 4Q GDP.
In the 3Q, GDP rose by 2.0% (annual rate). For all of 2015, GDP rose a disappointing 1.975% following 2.4% in 2014 and 1.5% in 2013. For the six years since the recession of 2008/2009, the US economy has grown at a feeble pace of 2.03% (average annual rate).
The deceleration in GDP in the 4Q primarily reflected downturns in non-residential fixed investment, state and local government spending, exports and a deceleration in consumer spending. While consumer spending was slower in the 4Q, personal consumption added 1.66% to overall growth.
Gross Domestic Product is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period. The Commerce Department estimated that US GDP was $17.94 trillion in 2015, up from $17.62 trillion in 2014.
2015 Corporate Profits Fell by Most Since 2008
While the 1.4% increase in GDP was better than expected on Friday, there was some really bad news in that same report. The Commerce Department reported that pre-tax corporate profits plunged by 11.5% in the 4Q, the most since the 4Q of 2008, following a 1.6% decline in the 3Q. For all of 2015, corporate profits fell 3.1%, the most since 2008.
The higher than expected drop in earnings was made worse by a $20.8 billion settlement payment that BP (British Petroleum) made to the US government late last year as a result of the 2010 oil spill in the Gulf of Mexico. If we strip this one-time payment out of BP profits, then corporate earnings were down apprx. 7.6%in the 4Q. That’s still a bad number.
Earnings are being weighed down by weak productivity, rising labor costs and in many cases, the plunge in energy prices. “If profits remain depressed, the prospects for capex [capital expenditures] and hiring will come under greater pressure,” warned Sam Bullard, a senior economist at Wells Fargo Securities. He is very likely correct. Let’s take a look.
This chart is a little hard to read. The blue line is corporate profits (year-over-year), and the white line isemployment (y/y). As you can see, there is a very high correlation between the two. History shows that when earnings fall, the economy often follows them downward into recession as profit-starved companies cut back on hiring and investment.
It is worth pointing out that the 4Q plunge in corporate earnings was heavily concentrated in the petroleum and coal industries, where profits plummeted by as much as 75% in 2015 as energy prices collapsed. That makes it a little less worrisome from the point of view of the overall economy, which should benefit from lower energy prices.
However, Jesse Edgerton, an economist with JPMorgan Chase & Co. in New York, was less sanguine. Yes, the poor earnings number was due to energy companies struggling with lower oil prices and manufacturers hit by a strong dollar, he said.
“But it also likely reflects the beginnings of a profit-margin squeeze driven by tighter labor markets, rising wages and weak productivity,” he added in an e-mail to clients. And that, he suggested, is something to fear. Time will tell.
Should We Trust the Government GDP Numbers?
I have been closely monitoring government reports of many stripes for over 30 years, and I must admit there have been times when I thought that more than one report was well off the mark or even dead wrong. However, most important government reports are subsequently revised, often two or three times or more. That doesn’t mean they always get it right, but I figure they get it about as right as anyone else in the business.
I will also tell you that I have had more than my share of clients who believed that most government reports are rigged in one way or another – kind of a Conspiracy Theory, if you will. I have discouraged those arguments for years, if for no other reason than the fact that the heads of these various government agencies tend to change every time there is a change of party in the White House. Still a lot of people are very skeptical when it comes to government reports.
Well last Thursday, CNBC’s Steve Liesman and his gang of analysts released a new report which sheds new light on the inaccuracy of the Commerce Department’s GDP reports.
The report begins with its Conclusion up front:
“An in-depth analysis by CNBC of the government’s reports on gross domestic product suggests large and persistent errors that should give investors, business executives and policymakers pause in relying on the data for key decisions.”
It’s an eye-opening report, and I’ll summarize it for you below. Remember that the Commerce Department releases three monthly estimates each time it reports on GDP: the advance estimate late in the month following a quarter-end; a second estimate a month later; and then the final revision a month later.
Before I get into the numbers, I want to emphasize that CNBC found no evidence of any systematic overstatement or understatement of growth, just persistently large revisions. In other words, no Conspiracy Theory here. [FYI, the emphasis below is mine.]
CNBC looked at each quarterly GDP report going back to 1990 and found an average error rate of 1.3 percentage points. So an initial report of 2% growth later could be revised up to 3.3% or down to 0.7% on average.
Government GDP Numbers -CNBC also found:
- The error rates in the second and third estimates of GDP are the same as the first. So despite more time and data, the error rates will often be just as large three months after the end of the quarter as they are one month afterward.
- About 30% of the time, the government gets the direction of growth wrong. That is, GDP initially shown to be higher than the previous quarter could in fact be lower, and vice versa.
- The error rates haven’t improved over the decades despite vast improvements in computing power and communications speeds. The size of the revisions from 2008 to 2013 is the same as those from 1990 to 1995.
Liesman & Company rightly warn that these persistent errors have potentially important policy implications. Here are just two examples they cite:
On April 30, 2008, with the Great Recession just gathering steam, the Federal Reserve cut interest rates by one-quarter point to 2%. That same day, the Bureau of Economic Analysis [part of the Commerce Department], the agency that produces the GDP report, announced that the economy was growing an anemic 0.6% but still growing.
Yet in subsequent years, that GDP growth would be revised to show a contraction of 2.7%, the biggest decline in 17 years. While the Fed was acting aggressively in bringing down rates, the question is whether it might have done more had it known the severity of the decline earlier.
Here’s another example of a miss, this time in the opposite direction. In the 2Q of 1992, as President George H.W. Bush was running for re-election, growth was reported at a meager 1.4%. It would be revised up in subsequent years, after the election of Bill Clinton, to a strong 4.5%. Wow!
The above are just two examples of many egregious errors on the part of the bureaucrats at the Commerce Department’s BEA. It is equally important that these substantial revisions may not be discovered until a year or two after the initial three monthly estimates.
Obviously, CNBC’s findings raise warning signs for investors, policymakers and business executives about reacting too strongly to government reports on economic growth. Those warnings are especially important now that GDP growth is only around 2%.
CNBC released the results of its study early to numerous economists to get their reactions. Liesman reported that the majority of those economists contacted did not know about the average error rate of 1.3%.Most assumed that error rate was half that amount or even less.
Liesman contacted Brent Moulton, associate director for national economic accounts at the Bureau of Economic Analysis for comment. “We’re working to try to get more accurate data in time to improve the advance GDP estimate,” including faster data on wages from the Bureau of Labor Statistics, he said. Never mind that the error rate has not improved in over 25 years!
And speaking as a true ensconced bureaucrat, he emphasized that “Revisions are not errors – they represent improvements to the GDP estimate as more information becomes available.” Yeah, right! The two examples above are ERRORS, no doubt about it.
So what does this tell us? First, it tells us that any GDP report we see – whether it’s the first, second or third estimate – could well be off by 1.3 percentage points or more. So a 2% estimate could end-up at either 0.7% or 3.3% on average.
Second, it tells us that we should not make important decisions, whether they are business or investment related, based on the GDP reports which are likely to undergo substantial revision in the years to come.
And third, since the government’s error rate on GDP has not improved significantly since 1990 – especially in light of the dramatic improvements in technology – this can only mean that these bureaucrats areconsistently inept or unwilling to change or both. I expect it is both!
As noted at the beginning, I have been diligently reporting the quarterly GDP reports for decades. Now I have to decide whether to continue doing so, knowing that the error rate is much larger than I would have expected.
I’ll probably continue to bring you the GDP reports since they often affect the markets and the Fed’s decisions… but with a frequent reminder to take them with a grain of salt.
Celebrating 30 Years of Marriage to My Best Friend
On Easter weekend, Debi and I celebrated 30 years of marriage. We met in the workplace in 1982 when I joined the brokerage firm where she worked. Over the next few years, we became best friends, well before we were romantically involved.
The romance began in 1984 and we were married in 1986 in Dallas on Easter weekend. Since then, we have always celebrated our anniversary on Easter weekend, even though Easter varies on the calendar from year to year. It just seems fitting to celebrate our anniversary on that special weekend.
We have two children – Tyler age 26 and Jordyn 24. They are two great kids – I should say great adults. They both earned their Master’s Degrees in college and are very successfully employed. Neither one has married so far, so no grandkids yet. Most importantly, both are dedicated Christians who are very active in their respective ministries.
After three decades of marriage, I am blessed to say that Debi is still my best friend, business partner and the love of my life. And after 30 years, she still looks as good as ever! Here’s a new photo that we had taken to celebrate our anniversary.
Your feeling very lucky Editor,
Gary D. Halbert