Revisions! This is the name of the economic data game.
Written by: Benjamin Bimson CIMA® / BCJ Financial Group
Whenever economic data is first released, especially corporate profits, GDP (Gross Domestic Product) and PCE (Personal Consumption Expenditures) go through a process of being revised multiple times before the data is deemed to be “accurate.” In fact, CNBC released an analysis this week of data they claim shows that GDP numbers are inaccurate by an average of 1.3%. If this data is true, it means that first, second, and third revisions are all off by an average of 1.3%.
The number can go either way. 30% of the time, the direction of second and third revisions is inaccurate. So really the number can be off by 1.3% either direction based off of the first estimate. 30% of the time, even if revised up, the number could still be revised up to 1.3% lower or higher from the initial revision.
This past week GDP third revisions were released which showed that the 4th quarter grew more than initially thought. The second release had shown 4th quarter GDP at 1%. This past week the third advance report revised it up to 1.4%. With the error rate assumed above, the numbers could still be revised further!
One of the most interesting data points that was released last week was corporate profits. During the 4th quarter of 2015, corporate profits declined by 7.8%. This brought total 2015 corporate profits down for the first time since the great recession. In 2015 corporate profits declined 3.2%. To give this context, corporate profits increased 9.1% in 2012, 1.9% in 2013 and 1.7% in 2014. This is a little on the concerning side and needs to be something that we keep our eyes on. Corporate profits decline for a lot of reasons, but they are important to overall economic health.
This is especially true when we considering personal consumption was the single largest contributor to the GDP growth, according to the Bureau of Economic Analysis. Wages haven’t grown much, but unemployment has dropped to the lowest levels in 40 years.
The Real Issues
So what is driving consumption? It may be good deals, but more likely it is low inflation and especially lower energy costs driven by the low oil prices. As much as the market is demanding and wanting oil to trade higher to take pressure off of the debt associated with energy, higher oil may cause lower consumption. Lower consumption would be bad for GDP and corporate profits (already under heavy pressure).
One of our clients pointed out an article in The Economist that concisely brings up a big issue regarding corporate profits that is independent of the declining corporate profits mentioned above.
The article makes a very important point about the concentration of profits. Profits in many sectors are more concentrated than ever before. They are also showing a higher return on capital. No one reason can independently be highlighted, but the fact is that these corporations (similar to discussions we have had on FANG stocks) are getting wealthy. Unfortunately not much is getting to employees or Main Street.
A healthy economy is where corporations make money and that gets cycled back onto Main Street for the “average Joe” to spend, save and invest. It doesn’t look like that is happening.
A small portion is getting the biggest slice and the smaller folks (especially small business) are getting a smaller piece. Below is a chart that illustrates this issue. On the X-axis the numerical values represent the percentile of corporations while the Y-axis has the percentage of total industry revenue. Notice how the biggest companies are taking the most.
Unfortunately, the only fix that this article offers is legislative in nature. This would make it easier for businesses to grow and break into the marketplace, grow profits more sustainably, and return it to Main Street for the betterment all (individuals, country, economy). Sometimes it is hard to look at our current political landscape and have great optimism about that happening.
Therefore, despite the more recent calm in the markets, positive data revisions, and news, there are still very good reasons to have some caution in how we are investing. Sometimes it can seem so hard to look at a portfolio and compare it to the S&P 500 or Dow Jones without feeling left out. When we look at how, who, and what is driving the machine, it just makes more sense to be a little cautious, look for sustainability of growth, and not take unnecessary risk.
This is not an argument for being un-invested. We just want to be cautious with getting carried away in surface level comparisons. The value of investment management is the ability to help navigate through all investment landscapes and get clients to their intended destinations. This takes discipline and patience when markets are behaving in a frustrating manner. Now is one of those times.
We hope that you all had a wonderful Easter weekend with family and friends! In the end, that is more important than most other things.
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