Oct. 3, 2022

Let's Get Real

Thursday, we got what looked like a piece of good news on the Economy. It was the third and final release of the Second Quarter, GDP, the Gross Domestic Product, our best measure of the Economy's big picture. GDP adds up everything in the Economy, all the goods and services, and gives us the total. And it's usually excellent news.

The United States has an economic growth rate that is second to none. If we go back 62 years ago, to 1960, our country's GDP was barely over one-half trillion dollars. In the last full year reported, 2021, the nation's GDP eclipsed $22 trillion. The Economy has grown by 44 times in that time. Remarkable.

It's been a straight trend-line from the 60 low, to today's high, with only a few divergences, most recently the 2008 Financial Recession and the 2020 Covid Pandemic.

Thursday was the third and final survey of the Economy. It is the one that goes into the record books. As you can imagine, measuring an economy as large as ours takes time, with many inputs before the data is complete. So the Census Bureau provides two preliminary estimates for GDP and the final "official" estimate just about 90 days after the quarter ends. When we received this latest reading on GDP, it looked like things were finally getting back on track.

And, as I say, this report had some excellent news. The essential good news was that the latest measure showed a much smaller decline in GDP than initially estimated. The Reports said that, GDP is down only 6/10ths %, not the 1.6% previously estimated. At least, that was our first take.

A Smaller decline in GDP was an excellent piece of news with some far-reaching implications. Perhaps this horrific bear run might be closer to ending than we thought. For individual investors and professional money managers, it would mean that the market fundamentals may be gaining some strength. And for the Federal Reserve, which sees inflation as the number one enemy, this news would give them more latitude to continue their rate hikes.

However, measuring the Economy has become especially tricky because of the current high inflation rate. This same GDP report also told us that GDP Prices are rising at a 9.1% rate. 8/10th% higher than the quarter before, as inflation continues to accelerate (at least through Q2).

So the question is, are these GDP numbers before or after accounting for the effect of inflation? And the answer: before inflation.

To understand where this Economy stands, we need to adjust the GDP Report to reflect those 9% higher prices (annualized).

When we do that, we find that the much-touted GDP growth improvement was purely ephemeral. That 1.6% decline in GDP was right the first time. There was no improvement. That was just an inflation illusion. The 1.6% decline stands in real terms (after accounting for inflation). So, there is no strengthening in this Economy. It is as bad as first reported.

Indeed, this Q2 GDP report was the second quarter of negative growth that the Economy peaked in the fourth quarter of 2021 and has been lower ever since. In real dollars (not inflated dollars), GDP Peaked at an annual rate of $20T in Q4 2021, 19.9T in Q1 2022, and 19.8T in Q2 2022.

In real terms, this Economy continues to head south.

So, let's go back and review a couple of the implications we made.

For individual and professional investors, this raises a caution flag. These financial markets may not have solid fundamentals behind them. Better take a second look at risk exposure.

For those politicians and pundits who like to tout the improving Economy, we need to ask whether they're looking at current dollars (with an inflation boost) or real dollars (without inflation). It makes all the difference.

For the Federal Reserve, their Quantitative Tightening has already had an impact. This Economy is dramatically weaker than it was in the early 1980s when Paul Volcker tamed inflation. Unlike the Volcker model, the Fed does not have room to continue to raise rates.

Today's Economy, in real terms, is struggling.