Forget the noise—let’s look at the data. Are we headed for a recession?
KEY TAKEAWAYS
MY HOT TAKES
The mentalist. You couldn’t possibly avoid it; I am sure that you have heard that we are headed for a recession. Well, I have actually brought it up… um, several times in the past few weeks, but I think we need a bit of clarification. To be clear, I am not warning that we are headed to a recession, however, some of the most prophetic, leading indicators–at least my personal favorites–have been sort of flashing yellow. Even if you only read 50% of my daily posts (shame on you 😉) you would know that consumer confidence and personal expenditures (ie consumption) are my all-time favs.
Here is my well-known thesis: confident consumers consume. Simple, right? If you are confident, you spend money, and if you spend money, you grow GDP, because consumption makes up ⅔ of GDP… and vice versa. This extends beyond consumers. Confident businesses invest in expansions. If you are a CEO and you expect a positive business environment, you commit to buying more equipment, expanding plants, etc. Business investment makes up another 15% - 20%. Never mind, I am going to show you the exact breakdown of Q4 GDP.
So, 84% of US Gross Domestic Product is driven by consumer confidence and CEO confidence. The Government spends based on fiscal policy, and, as we have recently learned, also the President. A negative net export number simply means that we have a trade deficit with the world. In other words, we buy more foreign products than foreign folks buy from us which results in more money leaving the US than coming in. You should already have an answer, but I will continue.
The reason everyone is in a tizzy without even having read the last two paragraphs of today’s post–OR THE DOZENS OF OTHER TIMES I HAVE WRITTEN ABOUT THIS–is something called The Atlanta Fed’s GDPNow indicator. Check out this chart, then keep reading.
This is, indeed, a chart of the Atlanta Fed’s GDPNow indicator. The model tries to predict the GDP of the current quarter. Positive numbers mean economic expansion, while negative numbers mean contraction. All the way on the right-hand side of the chart you will notice how drastically the blue line dipped from positive to negative territory. Ya, that is what has everyone’s eyebrows stuck in the up position. You see, even politicians can’t ignore the math, and are forced to come up with a narrative around these findings.
Let’s take a step back and try to understand why this GDPNow number is flashing red right now. GDPNow is a purely data-driven model that updates dynamically with each new economic release—i.e. no subjective guesswork, just straight-up numbers (just how I like it). It crunches data from key GDP components, including personal consumption expenditures, which factor in retail sales, auto sales, and services spending, as well as private fixed investment, covering construction, equipment purchases, and software spending. The model also adjusts for changes in inventories, tracks net exports by analyzing real-time trade data, and incorporates government spending at the federal, state, and local levels. On top of that, it pulls in industrial production, labor market indicators, and price indices like CPI and PPI to refine its estimates. That’s a lot of stuff to stuff into a statistical model… but not really if you understand econometrics. Don’t worry if you don’t, I know a thing or two about it 😉, and I can tell you that it is a simple and elegant model that is highly accurate.
So, if you followed all that, you would see that it tracks all those components that go into GDP, and based on how well those leading indicators explained changes in GDP historically (that is stats talk), we are able to come up with an equation that can predict GDP with a mean absolute error (MAE) of around 0.5 to 0.8 percentage points. Don’t get nervous– I'll just tell you that, statistically, at a 95% confidence level, GDP in the current quarter will fall between -4.38% and -0.42%. So, with high confidence, the best-case scenario still has us in the red, but marginally. Cold comfort.
So now that you had a quick lesson on econometrics, why do you think that the prediction took such a deep spill recently? Well, we already know that consumption took a precipitous and unexpected drop last month. That’s a big one. Also, in case you missed it, Retail Sales fell by -0.9% in January, which is a non-small move (that means a big move). It hasn’t declined that much since March 2023, and it has only fallen by at least this amount 7 times since the pandemic. Non-small, indeed. On the investment front, construction spending is a big one, and it too has leveled out recently and declined. I won’t bug you with a chart, but if you saw what I am seeing, the trend would be clear, and GDPNow sees it. 👀 Finally, there is Government spending. More is good for GDP and less is bad. I am not commenting on whether it is morally or politically good or bad–just mathematically. We know which way Government spending is going.
So, now you too, know a thing or two about the US’ GDP and econometrics. Now you can dazzle all your friends and tell them that, based on what you have been observing, that you had a vision of economic strife in the future. Your friends will hail you as a clairvoyant and applaud you. On second thought, they are more likely to hail you as a harbinger and not invite you to the next party. Or, maybe, just send them to the Atlanta Fed’s homepage, stay focused on your long-term goals, remain calm, and order another round for your friends–they will applaud that for sure.
YESTERDAY’S MARKETS
Stocks had a wild session yesterday, selling off on news that Trump would double metal tariffs on Canada in response to its ‘power tax’ on the US. Tech shares were spared and ultimately led indexes off their lows. There are 7.74 million job openings in the US, according to yesterday’s JOLTS release–better than expected… slightly.
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