Thursday, May 31, 2007

Revision of Q1 GDP to 0.6%-ignored by market?

According to Marketwatch:

"There was next-to-zero market reaction to the Commerce Department's report that gross domestic product was cut to a 0.6% estimate, down sharply from an initial projection of 1.3%.

The 0.6% growth rate marked the slowest pace since late 2002. Economists polled by MarketWatch had expected growth of 0.7%.

The details of the report showed that consumers once more remained active, while the business sector was beset with sluggish spending and shrinking inventories.

Analysts said investors were able to brush off the report because the release of new Federal Open Market Committee meeting notes on Wednesday showed inventories returning to respectable levels. This could spell stronger growth in the present and future quarters.

"The weak figure is partly the result of a sharp downward revision to inventory investment during the quarter, which more than likely will result in stronger GDP figures in the next two quarters, including the current quarter," said Tony Crescenzi, chief fixed-income analyst at Miller Tabak.

"The inventory drag cut a percentage point from GDP in the first quarter after cutting 1.2 percentage points from GDP in the previous quarter," he said. "The removal of this drag will provide a significant boost to GDP. " businesses cut back production because their inventory levels were way too high...not surprising as demand for any products related to new home construction and home remodeling has been shrinking due to the housing bust. As consumers will no longer be able to draw significant amounts of cash from home sales or refinancings, and foreclosures and short sales increase, consumer spending is likely to weaken in Q2 and Q3.

So, depending on any surprise revisions in the final number, we have at least a "growth recession" as Nouriel Roubini says today, and could have actual negative GDP growth for the quarter. I think the proposition that production will increase because the inventory overhang was worked down is absurd, principally due to the likely weakening of consumer spending due to the housing bust factors I mentioned.

A positive aspect of this quarter's results is what happened with federal spending: it decreased 3.9% from the previous quarter, due to a 7.3% decrease in defense spending!

Also, the total contribution to the quarter's number from government spending at all levels was only .19%.

Finally, the collapse of the residential housing sector shows up in the GDP report with decreases in residential investment for the last six quarters as follows:
-.9    -.3  -11.1  -18.7  -19.8  -15.4

I would expect to see a dropoff in personal consumption as the negative effects of the production cutbacks and shrinkage in the housing sector on personal income work their way through the economy.

Roubini reports in the above linked post regarding the outlook of executives from one large institution regarding the housing bust:

"This writer was the featured speaker the other night at an event organized by one of the top 10 global financial institutions; after I gave my bearish outlook for the US economy and the housing market (in a debate with the chief economist of this firm), the four senior analysts of this bank for the housing sector, the mortgage lender sector and the MBS sector gave their outlook (it is all in public reports available for clients/investors of this firm).

In brief, their view is that: the housing market is still weakening and - based on their May survey of traffic - housing sales traffic is close to dead; it would take developers to shut down all new construction for almost a year to get rid of the excess supply of unsold homes; thus, downward home price action may continue for the next two years; the credit crunch in the mortgage market is only at its early stages and the distress and crunch is spreading from sub-prime to Alt-A and near prime mortgages; the major mortgage lenders have not yet started to get a reality check on how bad their assets are and properly mark them to market; the ABX index (the BBB- tranche) collapsed from near parity down to 60 in the last few months and has now recovered to close a still low 67; but, given how lousy were mortgage originations in 2005 and 2006, deliquencies in subprime will further increase in the next few months and further downward pressure in the ABX indexes may be expected. "

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