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Driving With a Broken Navigation: The Pitfalls of GDP Measurement

Fixed Income Portfolio Manager, Portfolio Strategist
Johnson Institutional Management, Cincinnati

Driving With a Broken Navigation: The Pitfalls of GDP Measurement

In the age of smartphones, most of us now carry around pocket-sized super computers capable of performing functions which once required mainframes the size of a Volkswagen. With GPS map applications at our finger tips, it’s become almost impossible to get lost. Unfortunately for investors, the most popular economic compass has grown increasingly unreliable. Although GDP offers a dependable snapshot of our economy over full economic cycles, investors who rely on quarterly GDP reports for clues about our economy’s wellbeing must be aware of several measurement pitfalls.

• Much of the data used to compute the initial estimate of GDP is just a guess. In fact, up to 59% of the data used to calculate investors’ first look at GDP is either an estimation or based on historical trends! Because this early look is largely incomplete it is often subject to large revisions. Sadly, it’s the initial estimate that tends to move markets the most while the more reliable revisions are mostly ignored.

• GDP math punishes globalization. GDP was born in the wake of the Great Depression as a way to guide policy decisions. The trouble is, a lot has changed since the 1930’s. While GDP math dictates that rising imports are a drag on economic growth, they are often a sign of stronger domestic demand. So while GDP is “slowing” the economy could actually be rapidly expanding.

• Modern inventory management leads to increased economic volatility. GDP accounting was designed for an economy dominated by manufacturing. Decades ago, companies managed their inventory for long term production cycles. However, today’s lean inventory management practices dictate that companies either stock up or draw down inventory much more often. At times, inventory adjustments can have an outsized influence on GDP, accounting for more than half of the quarterly change in economic output!

• First quarter performance has been persistently poor. By now, you’ve probably heard every excuse in the book, from “bad winter weather” to “lingering impacts of the financial crisis”. Whatever the true cause, seasonal adjustments have persistently punished Q1 growth. In fact, the average first quarter GDP growth has suspiciously been less than half the rate of overall growth.

To be clear, we aren’t advocating that investors ignore GDP. After all, according to a study by Goldman Sachs, GDP is still the second most influential piece of economic information driving bond yields. Instead, investors need to understand the limitations to GDP accounting and how these limitations can send conflicting signals with overall economic growth. In order to alleviate the confusion, we recommend supplementing GDP with Real Final Domestic Sales to improve your economic roadmap.


Image source: The Economist

Brandon Zureick is a Fixed Income Portfolio Manager and Strategist with Johnson Investment Counsel (“Johnson”).

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