Fourth Quarter 2010 GDP: First Cut in Line with Expectations

Morris Segall      consumer spending outlook in 2011, Fourth quarter and full year 2010 GDP, highest level of consumer spending, inventory restocking cycle, negative impact on GDP from low inventory accumulation

This past Friday, the Commerce Department released its first reading on the fourth quarter and full year 2010 report of U.S. GDP. As we stated in our website article, “Great Expectations-2011″, January 6, 2011, we projected fourth quarter GDP to be stronger than that of the third quarter led by consumer spending.  Fourth quarter GDP increased at a  3.2% annualized rate, within the 3%-4% range we had projected in our January 6th article. It was the largest increase in GDP since before the recession,  matching the 3.2% of the second quarter of 2007. In the preliminary numbers released on Friday, Personal consumption expenditures led the advance, growing at a 4.4% annualized rate, the largest increase since the 4.5% annualized growth in the first quarter of 2006.  Personal consumption expenditures comprised over 3% of the total growth in fourth quarter GDP, once again the largest increase since the 3.1% contribution to total GDP in the first quarter of 2006. Personal consumption surged (up nearly 22% annualized)  in durable goods and increased strongly (up 5% annualized) in nondurable goods. Both levels of growth were at pre-recession levels. However, unlike previous reports on GDP growth since the recovery from the recession, Private domestic investment recorded negative growth (-22.5% annualized), due to a large decline (over $100 billion) in inventory investment in the fourth quarter from third quarter levels. Indeed, the decline in private inventory investment reduced fourth quarter GDP by nearly 4%. The decline in private business investment in the fourth quarter was the first since the 18.5% decline in the second quarter of 2009, just as the recession was ending. Bolstering GDP in the fourth quarter was an increase (+8.5% annualized) in net exports as imports fell and exports strengthened. Government spending was negative in the quarter with a reduction in federal defense spending and a continuation of reductions in state and local spending.

The first reading on GDP growth for all of 2010 was an increase of 2.9%, consistent with our forecast of 3%. Clearly the fourth quarter surge in consumer spending pushed full year GDP growth to the 3% level which was not visible at the end of last summer as the economy sagged during the late spring and summer months. However, as we noted in our January 6th website article, we do not believe the rate of increase in fourth quarter consumer spending can be sustained into the first half of 2011 as the level of spending is far outstripping the gain in consumer income. We believe the consumer will restrain his spending in the first quarter to restore liquidity he drew on to finance his purchases in the fourth quarter. Our economic analysis just published on the Presentations page of our website (www.spgtrend.com) reveals no increase in consumer credit card debt through November of last year. We thus believe consumer spending was done with cash and debit cards. In addition, discretionary consumer spending in the first quarter will be suppressed by the harsh winter weather curtailing shopping at the malls and the large increase in food and fuel prices which will “pinch” consumer incomes.  A rebound in consumer spending may occur in the spring and summer of this year as the weather thaws and pent-up consumer demand reappears. However, the degree of consumer re-emergence will depend on the level of job creation in the first half of this year. While we have noted in our previous blog (January 9th) article on December unemployment, an improving trend in unemployment, conclusive evidence of a change in the chronic unemployment environment remains to be seen. 

Two further observations. Friday’s GDP report is the first of three. It is subject to material revisions as more complete data is collected over the months of February and March. Because the level of inventory accumulation recorded in this initial report is so low, we would not be surprised to see it revised higher and thus increase the readings on the fourth quarter and full year GDP for 2010. Second, the large increase in consumer spending in the fourth quarter depleted retailer’s shelves. There will be an inventory replacement cycle in the first half of this year which will partially fill the void of reduced consumer spending and keep the U.S. economy growing at a heightened rate.

Morris R. Segall, CFA, CIC