Thursday’s ugly economic data continued and some took note. GDP was much weaker at 1.5% vs prior 3.9%.

Much of this was due to sliding inventories.

We rely on Consumer Metrics Institute to explain it all to us.

Their summary is below:

Summary and Commentary 

This report is truly a mixed bag: the weaker headline is in some respects misleading, probably negatively impacted by aberrant inventory numbers and an over estimation of inflation. And yet at face value it shows somewhat weaker consumer activity and sharply lower commercial investments. Plus, exports may have started to fall off the cliff created by a stronger dollar and weakening global economy. 

The Good: 

— The inventory line item is problematic even beyond the noise that it introduces to the headline number. In principle, over longer time spans it should be a mostly zero sum series, reverting to a mean that closely mirrors the economy’s organic growth (i.e., whatever large numbers it subtracts this quarter are likely to be given back in a future quarters). Over shorter terms it is supposedly an indication of how companies are adjusting inventories to reflect changing customer activity (in this case shrinking inventories in anticipation of weakening sales). However, it can also be held hostage by rapidly changing deflators and exchange rates — resulting in anomalies and aberrations in the data series that have very little to do with physical inventory levels. We suspect that the latter is at least somewhat in play with this report. 

— If we remove the noise created by the inventory data, we are left with the BEA’s own “bottom line” — the “real final sales of domestic product.” That number shows a very respectable +2.93% growth rate, down “only” -0.97% from the astounding +3.90% number reported for the second quarter. Given the suspect nature of the inventory data, this is probably a somewhat closer read on the economy than the headline number. 

— We generally criticize the BEA for using low deflators that create overly optimistic headline numbers. Arguably, report this is the reverse case — where over reported inflation is creating a pessimistic headline. Using the current dis-inflationary CPI-U data from the BLS as an alternate deflator results in a headline number in excess of 3% — and the “real final sales” number becomes a “happy days are here again” +4.54%! 

The Bad: 

— The economic growth provided by consumer spending and commercial investment is reported to be softening (if we believe the BEA’s deflators). 

— Over recent years the BEA has reported economic growth during the winter (fourth and first quarters) that has materially lagged the growth that they have reported during the summer. It seems that their “seasonal adjustments” consistently fail to correct for seasonally bad weather. If that pattern continues, we can expect their data to disappoint over the next two quarters. 

The Ugly: 

— Exports. Their contribution to the headline number more than halved quarter-to-quarter. The soaring dollar and plunging global economy have likely caught up with US exporters. In coming quarters we may look favorably back on a time when exports provided any growth at all. 

A mixed bag indeed: the headline plunged, but the residual growth is likely under-reported and distorted by aberrant inventory data. Meanwhile, (at face value) the core domestic economy seems to be transitioning to slower growth, with exports leading the way. 

That said, we frankly don’t know if anyone (including the FOMC) can conclude much about the true state of the US economy from this report