The GDP Litmus Test

Unless you do your own economic forecasting, you are a consumer of economic data.  Where do you shop?

The Data

The preliminary report of first quarter GDP showed an increase of 0.6%.  Taken on its face, this is very low growth — below potential and a cause of distress for many.  No one would like this as a permanent condition.

If however, this proved to be the low point in the current cycle, it might be something like the "soft landing" that almost everyone thought was impossible two years ago.

It makes for an interesting question.  Who offers insight on the GDP question?

The Sources

We are going to stick to sources that we feature — all respected for various reasons — as part of this little test.

The Realists

James Hamilton at Econbrowser is no perma-bull.  He has been pretty tough in his economic assessments and skeptical about the economy and stocks.  It has sometimes been at variance with our own viewpoint, but always worthy of respect and attention.  Readers should note Prof. Hamilton’s recession probability indicator.  He wisely observes that we may experience a recession that does not have two quarters of negative growth.  (Please read the entire article, good charts, good info).

I believe there is an important benefit to having a purely objective,
data-based algorithm for making these declarations. The numbers are
reminding us that if, for example, the tax rebates were to keep GDP
growth positive in the second quarter, we would end up characterizing
the most recent experience as a period of slow growth rather than a
typical economic contraction.

Dick Green at is an excellent observer with good economists on his staff.  He has had a very good read both on the economy and stock performance for the last several years.  For some reason, his excellent observations seem not to get much play in the blogosphere.  As long-time subscribers to the "Platinum" service, we are surprised that more people do not read the valuable free content from this source.  The following is the free summary about GDP:

The first quarter increase in real GDP at a 0.6% annual rate undermines
concerns that economic trends are deteriorating rapidly and even that the
economy is in recession. This is not an aberrant number. Inventories added 0.8%
to the overall gain, and skeptics will be quick to point out that would have
declined at a 0.2% annual rate without this swing factor. However, inventories
do reflect economic activity and belong in the calculation. The other component
trends reflect surprising resilience and even strength that suggests the outlook
for second quarter GDP is surprisingly good.

Calculated Risk is concerned that non-residential investment has turned negative.  It is a slight downturn, but certainly something to watch.  Check out the excellent charts.

The Optimists

David Malpass, in commentary distributed to Bear Stearns customers (like us) made the following observation:

We expect an economic recovery in coming quarters in response to generally good global growth conditions (record number of people working), low real interest rates in the U.S. and many parts of Asia, low inventories, and U.S. consumer resilience. While the negative inflection point in August relating to credit markets was severe, a deep pothole, we think most of the damage has been absorbed by the economy and priced into financial markets.

Just because we classify Malpass in the optimist camp, does  not mean that he is wrong.  He correctly called a sharp downturn from the credit crunch last August.  He now sees a rebound in response to stimulus.

The spread-out sequencing of the economic problems and the Fed’s concentrated response argue that we’re nearing the end of a slowdown/recession phase that began in 2006 with higher real interest rates and weakness in housing and autos.

We have followed the Malpass analysis for seven years, reading his work every week.  We did not start with an economic viewpoint (despite a few commentors who think the Old Prof is a Bush apologist!)  We have been persuaded by his analysis.  Our clients have profited from his work.

[There have been some very unfair criticisms of Malpass on the Internet, using very biased evidence.  Anyone who wants to move beyond the ad hominem attacks and look at the evidence will see why we think it is important to read David Malpass’s work.]

The Pessimists

Mark Thoma at Economist’s View has long been one of our daily reads (and is now added to our list of recommended sites).  He cites an argument that is nearly the exact opposite of the Malpass position!

After pointing out that the numbers will probably be adjusted, Thoma cites an article by Dennis J. Snower, suggesting that the blows to the economy will come in slow motion, with adjustments not equal to the effects.  Thoughtful readers should review the entire article.  This bears watching.

Barry Ritholtz applies his own interpretation of inflation data to conclude that the GDP report is really negative, a clear indication of recession.  We include non-economist (or self-styled "gonzo-economist") Ritholtz among the economists cited here since his work has very powerful mass appeal.

We would find Barry’s analysis more persuasive if he would do the following:

  1. Accept the fact that there are many inflation indicators.  A different market basket is used for each purpose, so the results cover a wide range.  Careful economists choose an indicator that fits the purpose.
  2. Offer an indicator of his own.  It is easy to appeal to the masses by pointing out prices that are rising.  It is more challenging to do something constructive.  Most of his viewpoint seems to rest upon some pre-Boskin measures of CPI.  Putting aside the question of whether the CPI is the right inflation measure for all purposes, the inflation measurement question deserves more attention.

The Litmus Test

The question for most of us — those who are consumers of economic data and interpretation — is the approach of the analyst.

Do they start with a consistent method and then draw conclusions?  Or do they start with a conclusion and then find an argument?

It takes knowledge, analytic skill, and a lot of time to reach this conclusion.  How many traders and investors can do this?

Stock Market Implications

Colin Barr has an interesting article on the recent performance of Legg Mason’s Bill Miller.   He  is skeptical, based upon some current positions, but his article is quite fair and balanced.  He includes Miller’s position, as follows:

You might assume the point is that no one should ever bring up Miller’s
recent negative returns, but that’s not quite it. “For value investors,
price is one thing, and value is another,” Miller explains. “When
prices move against us, it usually means that the gap between price and
value is growing, and our future expected rates of return are higher.”

and this:

…with most investors being fearful, I think it makes sense to allocate
some capital to the greedy side of that pendulum, and that means
putting cash to work in equities.

At "A Dash" we have a bit more confidence in Bill Miller.  It is based upon his method as much as his long-term performance.  It is so easy to reach erroneous conclusions by looking at short-term records.  Our own indicators, both fundamental and system-based, support Miller’s outlook.

Having said this, we are fully cognizant of economic challenges, including tomorrow’s ISM data and the payroll employment report, where we do not expect positive readings from these mid-April indicators.  One’s trading or investment decision depends more upon future economic prospects and earnings expectations.  It is all about time frames.

Which viewpoint will the market embrace?

You may also like


  • Barry Ritholtz May 1, 2008  

    Thanks for the homework assignment, but I have enough on my plate these days.
    How about this — why don’t you do some additional original research. Topic Suggestion: How accurate/inaccurate is the CPI measure of inflation. Identify where it accurately portrays inflation, and where there is “room for improvement.” If there are other measures worth considering, by all means feel free to suggest them.

  • Bill aka NO DooDahs! May 1, 2008  

    Put yourself in Barry’s shoes.
    If YOU had been predicting a recession since at least the summer of 2005, wouldn’t you be disappointed when, almost THREE YEARS LATER, the economic downturn came but WASN’T a recession?
    Under those circumstances, wouldn’t you be tempted to twist whatever data you could in order to “call” it a recession and finally (after THREE YEARS of PREDICTING RECESSION) be “right?”
    Plus, it fits the whole gonzo bear bullshit thing he’s got going on. “Everybody else is wrong, the world is going to hell, but LISTEN TO ME! I have the secret knowledge that will guide you through these times!” That’s the marketing script, and it works, check out his Alexa rankings …

  • blackvegetable May 2, 2008  

    As an unrepentant Malpass basher I am obliged to point out the following…
    “we’re nearing the end of a slowdown/recession phase that began in 2006 with higher real interest rates and weakness in housing and autos.”
    Malpass in August 2007…
    “”Housing and debt markets are not that big a part of the U.S. economy, or of job creation. It’s more likely the economy is sturdy and will grow solidly in coming months, and perhaps years.””
    I can appreciate that there will be credentialed economists and other sophists who will insist that the two comments above are NOT in conflict, but most of us are obliged to conclude that Malpass was completely wrong, not only with respect to his stated premise, but also the outcome….
    In response to Bill:
    “If YOU had been predicting a recession since at least the summer of 2005, wouldn’t you be disappointed when, almost THREE YEARS LATER, the economic downturn came but WASN’T a recession?”
    Even Malpass will now admit that a “slow down/recession phase” began in 2006 and if he believes it was a “recession phase” then, what are we to call what is going on now? Surely you are not going to limit the definition of recession to that banal “two quarters of negative growth” thingy, are you?
    and I can only imagine the chuckle the late Jude Wannisky must be enjoying with all this emphasis on orthodox economic qualifications…

  • Bill aka NO DooDahs! May 2, 2008  

    I don’t really give a sh*t whether it’s called one or not; I’m trading, and the economics either don’t matter, or are priced into the fundamentals and technicals of the stocks in a timely enough manner for my needs.
    My beef is with *ssholes who want to predict recession for 3 years running, and then when they don’t get it, redefine the terms to suit their prediction. If dipsh*t had wanted to predict a “per capita” recession with his own personal price index deflator, he shoulda made that pretty damn clear in 2005 when he first predicted a recession – otherwise, all the outside observer is left with is the “official” NBER definition. If he MEANT something else, he should have SAID something else, BEFORE making the prediction.
    Here’s a scientific proposal for ya ~ define what you’re trying to predict BEFORE you ff’in predict it, and then let it happen or not, and THEN measure the prediction.

  • blackvegetable May 2, 2008  

    “My beef is with *ssholes who want to predict recession for 3 years running, and then when they don’t get it, redefine the terms to suit their prediction.”
    With which part of Malpass’ admission are you struggling?
    If BS’s resident Pangloss can admit that we’ve been in a slowdown/recession since 2006, then why do you remain in such determined denial? Particularly if, as you insist, that as a trader, you don’t care?
    “otherwise, all the outside observer is left with is the “official” NBER definition.”
    The NBER “definition” is anything but….it is a judgment call with rather loosely bounded parameters…if you doubt it, get a look at their 1991 call…
    I’m beginning to suspect that Barry bluffed you out of a big pot back in college…..

  • Bill aka NO DooDahs! May 2, 2008  

    I neither read nor care about Malpass.
    Recessions are officially designated by the NBER. I don’t “deny” anything of the sort, I’ll just let them confirm it; they haven’t as of yet and may not. I have a side bet that there won’t be one which starts in 1Q08, but there’s no money on it, and if they call one starting in 4Q07 or 2Q08, I still win.
    I’m aware that the NBER definition is subjective. So? And your point is? If you or anyone else wants to “predict” a recession using your own “objective” definition, it would behoove you to DEFINE it before PREDICTING it.
    Barry’s one of many that do a disservice to retail investors with their “economic” writings. I include Mish and Roubini in that ilk, and could probably find a few others that fit the bill. I’ve never met any of them, but I hope (and actually suspect) that Barry’s a better trader than he is an economist or economic prognosticator.

  • Bill aka NO DooDahs! May 3, 2008  

    Jeff, I left a comment on another site regarding the birth/death indicator, and I thought it might be useful here:
    Keep in mind that making no adjustment for births/deaths is, in fact, a BIRTH/DEATH MODEL – one in which births always exactly equal deaths.
    Is that an accurate model, do you think?
    Over long (loooooonnnnnnggggg) periods of time, do you think perhaps that business “births” might exceed business “deaths?” If that is the case … then an accurate birth/death model should be adding jobs. Correct?
    It follows that, if over the long haul, business “births” outweigh business “deaths,” then the unadjusted data – which implicitly models births as EQUAL TO deaths – would be too low.
    If, over the long (looooooonnnnngggg) term, the ratio of births to deaths results in an exponential increase in the number of businesses (say even as low as +0.5% annually), then any accurate adjustment for birth/death would add an INCREASING number of jobs over the years.
    Just a thought.