Ignore the "weak" U.S. GDP report. GDP is a terrible economic indicator.

The initial estimate for U.S. Q1 2017 GDP growth came in at 0.7%. A lot of financial media outlets and big name investors said “this is the worst GDP growth in years. The U.S. economy is slowing down”. It isn’t. There were a lot of temporary and seasonal factors that made this a “weak” report (when in fact it was a decent report signalling healthy economic growth). In addition, GDP is a terrible economic indicator with massive and random quarter-to-quarter fluctuations.

The temporary and seasonal factors

For starters, Q1 GDP growth over the past few years has always been “weak”. So this is probably just a meaningless seasonal thing.

This quarter’s weakness was mainly attributed to weakness in consumption (personal consumption expenditures), which is that main part of the U.S. economy. HOWEVER, consumption does not determine economic recessions and expansions. Investment (residential investment, equipment and software, private inventories, non residential structures, and intellectual property) is what drives GDP in the long term. Investment is a leading indicator for the U.S. economy while Consumption is a lagging indicator. Over the years, Consumption tends to grow steadily as the economy grows and people have more money to spend. But the economy will only grow if businesses invest first!
Although Investment is a smaller part of GDP than Consumption, it is MUCH MORE volatile. That is why Investment plays a more important long term role in GDP than Consumption
A lot of this quarter’s weakness in consumption was temporary and should not affect the rest of 2017.

  1. Milder winter resulting in reduced spending on utilities.
  2. Delayed tax refunds.
  3. Sudden drop in political election spending. This happens in Q1 after every election year. This accounted for -0.3% to GDP.
  4. Sudden drop in auto sales.

*The sudden drop in auto sales has been a trend since early 2016. But declining auto sales is not a leading indicator for recessions. Auto sales peaked in 2004, more than 3 years before the 2008 recession began!
So although a slowdown in consumption spending weighed down on GDP growth, this should not be an issue for the rest of 2017.

The bottomline

We ignore GDP growth entirely when looking at the state of the U.S. economy.
GDP is subject to massive revisions. Sometimes these revisions can be in excess of 1%! So by the time the 2nd reading of Q1 GDP comes out, perhaps GDP growth will be bumped up from 0.7% to 1.5%.
GDP is also an extremely lagging indicator. The U.S. officially announced in July 2008 that the U.S. economy was in a recession, even though the recession had begun in December 2007!
The problem with quarter-to-quarter growth is that “growth” completely depends on what GDP was like last quarter. So if last quarter’s GDP saw a massive temporary surge, this quarter’s growth will be “weak”. That is why GDP can be negative even during the best of years. For example, GDP in Q1 2014 was NEGATIVE, even though the U.S. economy was on fire in 2014!

GDP simply has too much statistical noise, which is why we ignore this indicator. For the U.S. economy, focus on Retail Sales, Industrial Production, the Employment Report, New Home Sales, Initial Claims, etc. All the other indicators show that the U.S. economy is growing robustly.

4 comments add yours

  1. Not suprised. GDP has at bes he potential o be a lagging indicator. Once production and consumption drops its probable that he ship has already left dock. Add to that the highly cyclical nature of the measurement and it doesn’t tell you anything. I mean how many times do you hear about cyclically adjusted GDP around the holidays. Any number with such a large smoothing function would not be one I’d use for investment predictions.

    • That’s why in terms of business, business sentiment tends to lead business investment.

  2. I definitely don’t pay much attention to the GDP numbers that get thrown around. I know the media likes to hang on to those numbers breathlessly, I definitely agree that it’s a terrible economic indicator and there are much more useful numbers out there. But clearly some in the media like to get excited to report these numbers each quarter and tell the direction of the economy.

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