Economic Growth: It's More Than a Feeling
April 26, 2017 | Your Finances
Over the past few months there has been a significant spike in both consumer and business confidence. This has led to the latest Wall Street debate over whether this “soft data” signals actual faster economic growth ahead. The naysayers contend that these are merely “feelings-based” measures and argue that they have not translated into “hard data”: an accelerated pace of consumer spending, business investment and, importantly, overall economic growth as measured by U.S. Gross Domestic Product (GDP). Some believe the optimism is largely based upon a proposed agenda of the current administration, which may or may not materialize. While the president may have some impact on GDP in the short term, his agenda is unlikely to make a difference between outright growth and recession.
I’d concede that the recent business confidence increases are bolstered by the new administration’s perceived pro-business agenda. However, I’d note that we have long believed the U.S. economy was poised to get better—even before the election. In our estimation, confidence is rising largely because consumers have spent the past years increasing their savings, paying down debt and avoiding new debt. In fact, the Northwestern Mutual Planning and Progress Study out this month found 72 percent of Americans now feel financially secure. Consumers feel better financially, and confidence is likely to be further accentuated as wages continue their recent gradual acceleration.
Why Doesn’t the Hard Data Match?
Consumer confidence is soft data because it doesn’t measure what’s actually happening with the economy; it’s just how people feel. The hard data point most use to judge what’s actually happening is GDP. And while GDP has recently improved, it has not accelerated to the same extent that confidence has risen. However, I’d caution against making any decisions on the future growth prospects of the U.S. economy by fixating on recent GDP for three reasons.
1. GDP is a lagging indicator. Confidence numbers are considered leading economic indicators. Why? Because historically they have led the hard data. In other words, feelings often have been an indication of future actions. Put simply, be patient. The recent confidence surge is likely to show up in future growth reports.
2. The number isn’t perfect. The U.S. economy is a behemoth. Collecting all the data in real time is challenging and subject to numerous revisions. Indeed, after the first GDP estimate is reported, over the next two months it will be fine-tuned, and second and third estimates will be released. And even after the three estimates, there are annual and comprehensive reviews that may change the data years later.
The Bureau of Economic Analysis, which calculates GDP, notes that from 1993 to 2015, after all estimates are completed, the difference from the first to the last estimate has averaged 1.1 percent. With long-term potential U.S. economic growth currently estimated at approximately 2 percent, this is a significant margin of error around the initial reading.
3. First-quarter GDP is under scrutiny. Over the past years, economists have noticed a pattern in which the reported first-quarter GDP has been weak relative to the rest of the year. This should not be the case because most data are seasonally adjusted to take out seasonal influences. For example, consumers typically spend more in the fourth quarter because of the holiday season. To remove this seasonal effect and put all quarters on equal footing, data is seasonally adjusted. It appears that process is experiencing some challenges. For example, since the post-Great Recession economic recovery began in the third quarter of 2009, first-quarter GDP has averaged 1 percent; while quarters two, three and four are at 2.5 percent, 2.4 percent and 2.6 percent respectively.
Poised for Growth
Data is lumpy and subject to revisions. Don’t fixate solely on GDP. When we look to gauge economic health, we take focus more broadly on the health of the consumers, banks and corporations—and all three appear to be in good shape. When the economy is up, more often the not, U.S. stocks are, as well. Given that, we continue to believe that long-term focused investors will be rewarded with positive, albeit moderate, returns in the future.
The opinions expressed are those of Northwestern Mutual as of the date stated on this report and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment or security. Information and opinions are derived from proprietary and non-proprietary sources. Sources may include Bloomberg, Morningstar, FactSet and Standard & Poor’s. The gross domestic product (GDP) is the amount of goods and services produced in a year, in a country.