When Reality Does Not Conform (to your model): Change Reality

May 21, 2015

Central planners (central banks and their economic and political allies) are in a fix. But thankfully for them and their sacred economic models, it is not an unfamiliar one.

It is no secret that this economic “expansion” has been among the weakest ever recorded. Most recently Q1 GDP came in at a reported 0.20% (and will likely be revised lower). The Fed is on record as having expected 1.7% in Q1 GDP according to their models.

Over the past 72 months, the Fed’s predictions have been very consistent: consistently bullish and consistently wrong. In response, the Fed and their acolytes (Wall Street sell-side economists1) have decried the “weather” as the reason that our nation’s output has been so consistently punk. What model could have predicted that? As all of you know, weather itself is a new phenomenon that did not exist before the failure of Lehman.

But alas! All good excuses must come to an end. Many market participants2 and even the Federal Reserve Bank of Chicago, have seemingly driven a stake through the heart of the “weather” bogeyman. It would appear now that the market’s participants are less receptive to this excuse, so something more must be done: Enter “GDP Plus”!

According to the Commerce Department, this new number will “average GDP as well as what’s known as gross domestic income… called GDP Plus. It’s a measure that factors in both GDP and GDI, or gross domestic income…

The Commerce Department’s first look at GDP for the first quarter of this year clocked in at a seasonally adjusted annual rate of only 0.2%, and will likely get revised down… GDP Plus grew at an annual rate of 1.7% in the first quarter and averaged 3% growth over the past four quarters…

The second new data point is favored by the White House’s Council of Economic Advisers.

To those (seemingly too few) who are paying attention, this move is reminiscent of Commerce’s addition of the totally subjective metric of “intellectual property” to the string of pathetic GDP Numbers which persisted after the Great Recession a few years back. This move boosted the theoretical value of economic output by $500B in the year it was added. Now that the last trick has been digested, and GDP remains pathetic, it is time to try a new one.

Of course, the Commerce Department and their intellectual allies are old hands at this. Bill King of the eponymous King Report (http://www.arborresearch.com) reminds us that “In 1987 the US and obedient economists discarded GNP for GDP because the US turned from a net creditor nation to a net debtor. The negative international flows reduced GNP. So a new metric appeared.”

To be fair, our politicians and promoters are not alone. We should also remember that in the spring of 2014, the EU was chagrined by the fact that their own economic “growth” metrics showed them being stuck in a perpetual recession; so they did something about it. By adding in the estimated “contribution” from nefarious black and grey market activities (prostitution, illegal drug trade, human trafficking) it arbitrarily raised the GDP number by hundreds of billions. Wouldn’t you know! The perplexing recession was over! “Measured” (read: arbitrarily estimated) GDP rose in every European country. Since then, though, GreNot Done Yet:

If that were not enough, B of A and the SF Fed have now come out in favor or a “double seasonal adjustment” to the weak GDP data. Seasonal adjustments are meant to smooth out inconsistencies in the data due to weather or other ‘seasonal factors’ (such as the naturally slower pace of economic activity in, say, August). But clearly, one seasonal adjustment to the data is not enough!

This latest idiotic proposal is gaining wide praise. Why wouldn’t it? Have you ever heard Wall Street complain about adjustments that artificially boost economic activity? Now use your imagination…a 0.2% Q1 GDP print (which B of A themselves estimate will be ground down to -1.2%) through the magic of GDP Plus is now 1.7%! Now put some English on that ball! Double-Seasonally adjust it!

Lastly, you must be sure to announce it loudly and repeatedly through all media channels (WSJ, CNBC, Reuters, Bloomberg, Barron’s, etc ), and have all FOMC members comment loudly about this new “more realistic growth measure”. This last step is by far the most important because as everyone knows, the algos, robo-traders, momentum traders and lemmings – which make up over 70% of all trading -- must all digest these raw numbers and drive the market to new highs.

This is an absolute must.

Christopher Haydel

1. An example of deep economic analysis from Joe LaVorgna, Senior Economist for Deutsche Bank (courtesy Twitter/Zerohedge.com)ece has again descended into recession)

2. In a note dated 4/10/2015 B of A analysts stated: Is weather the main reason for recent weak economic data? While we would love to blame the weather for all of our bad forecasts, in reality it is hard to pin down weather effects. A recent paper from the Chicago Fed— “The effect of winter weather on U.S. economic activity”—is the best attempt we have seen in recent years. They look at detailed data on snowfall and temperature by state and for the nation as a whole. The results show that weather effects can have a significant impact on local employment and housing activity, however, when you add it up for the nation it becomes very hard to quantify. Looking back at the very severe winter of 2013-14 they find that bad weather can only explain part of the weakness at the start of the year.

This puts us in an awkward spot today. There is a bit of an urban legend that weather can explain all of the weakness in the first quarter of last year and hence could explain all the weakness today. However, hindsight is always 20-20. In real time, the slowdown last year was a major surprise to economists even though we get data on the weather before we get data on the economy. Moreover, this winter is not nearly as bad as last winter—last year we had three bad months, this year only February was unusually bad (Chart 1). Economic fundamentals point to stronger growth ahead, and that remains our forecast. However, we can’t completely explain the recent weakness and hence there is a risk that growth does not pick up.

HBA Admin -