GDP 1Q23: Devils and Details

We look at 1Q23 GDP, and the underlying variables look decent relative to the headline number as inventories again are a major distortion.

"It's the inventory decline, stupid." 

• The headline GDP of +1.1% is stronger than it looks under the hood with some solid PCE numbers and some decent lines in the Fixed Investment subcategories.

• The Residential line posted a much lower negative number after three brutal quarters.

• The typical distortions we often see are from the change in private inventories, so the question there on the -2.26% inventory hit to GDP is “Was this just a function of overstocking or does it reflect the expectation of weaker sales ahead?”

In this note, we comment on the main movers of the 1Q23 Advance Estimate for GDP. We usually write up the first cut at GDP (see GDP 4Q22: Thin Sliced 1-26-23, 3Q22 GDP: It’s the Big Little Things 10-27-22), but it is important to remember the numbers can swing around in the later updates.  We saw some big revisions last time around.

Below we detail the advance estimate 1Q23 numbers. These line items are an excerpt, but the table covers a lot of the big movers from the consumer and corporate sectors. These are the line items we like to watch and are taken from Table 1 of the BEA chart collection that comes with the release (Percent Change from Preceding Period) and Table 2 (Contributions to GDP).

We then break out some details on the fixed asset history in the following charts. The PCE line always rules given its disproportionate weight (68% of 1Q23 GDP). The fixed investment line is what we view as the “capex” line of the economy and is about investment in a range of categories that we traditionally associate with capital expenditures by companies.

The residential piece of the fixed investment line is getting a lot of focus after the spike in mortgage rates. Fixed investment overall is 17% of 1Q23 GDP and Residential just under 4% of that.

Government consumption is another 17.5% of GDP in 1Q23. We don’t include this in the chart, but Government Consumption was +4.7% and contributed an incremental 0.81% to GDP. That was the highest since 4Q20. Federal was 0.49% of the 0.81% contribution. Within Federal, National Defense posted a 0.21% contribution to 1Q23 GDP (Note: it would be fun to give some of the louder Congressional Reps a pop quiz on the defense contribution to GDP or the share of GDP and see if they can get within a material multiple of the correct order of magnitude). 

Those sectors (PCE, Fixed Investment, Government) add up to over 100%, but those numbers get haircut by other lines such as the trade deficit to get to 100%.

If there is one thing to take away from the 1Q23 advance estimate, it is that PCE was solid and both Goods and Services were positive. The line not shown above is the -2.26% negative contribution from the “Change in Private Inventories” that flows into the headline 1.1% GDP line.

In earlier commentaries, we also looked at those distorting line. We saw negative inventory contributions in 3 of the last 4 quarters (See Table 2 of the BEA release). The transition from COVID to the 2021 rally saw some big moves in inventories. Inventory shortages inflated the impact on some industries as they struggled to rebuild under the “just in case” rule after abandoning “just in time” inventory management. Then came the spike in short-term interest rates and a higher cost of building working capital. It has not been easy for some industries to plan in that mix of variables.

Personal Consumption Expenditures still rule…

The PCE line of +3.7% is the highest since 2021 and Goods is making a comeback after 4 negative quarters. Durable Goods were up sharply and Nondurable Goods slightly. As a sample, Motor Vehicles are up on improved supplier chains while Recreational Goods and Vehicles were also higher. Services were higher. Within that mix, Household Consumption and Healthcare were among two that stood out.

The story of the PCE line is that it is hard to have a recession with positive PCE and it is hard to have negative PCE with record payroll counts, a growing population, and a homebuyer base that had locked in super low mortgage rates in recent years. The “expectation” of rising unemployment and defensive consumer behavior can be discounted into equity and bond prices, but that is a forecast and handicapping exercise. It is most definitely not in the numbers of this GDP release.

The recession risk discount was evident in the fall but are not in equities now or in credit even if they seem to be in the UST market. That takes time to play out at sea level and in the trenches, but it would happen very quickly if the leaders of this country did something very stupid (like default on UST debt). Credit contraction coming out of the depositor panic can impact consumer behavior, but those with uninsured deposits are not the main event in a total population numbers game.

Fixed Investment shows mixed picture…

The question marks around how investment would play out in the face of a rising yield curve is getting some clarity. Overall, the fixed investment lines are mixed with some major ones weak and some solid (e.g., Structures). As we lay out in the table above, the headline number of Gross Private Domestic Investment posted -12.5% on weak Equipment (-7.3%) and Residential (-4.2%).

Structures includes more than traditional commercial real estate and includes lines such as oil and gas among a very diverse list. That level of granularity is for other commentaries. The “capex” lines saw some material revisions across the 4Q22 iterations, so we could see that again.  We detail the timelines for Nonresidential Structure and Residential below for some multicycle perspective.

The above chart is a favorite since it flags the insane residential housing bubble and how outsized that spending was relative to natural needs as lax credit and hyped-up valuations took the helm. Commercial real estate had more than its share of excess as well during the structured credit boom excess and inflated leveraged transactions that used real estate to hike price tags on LBOs and leveraged M&A.

The recent downtick in Residential is evident, but the bearish forecasts on Nonresidential structures will have some competing line items – both up and down – in the periods ahead with the IRA and infrastructure bills. We also might see potentially more spending in Energy if some obstacles are removed to select construction activity (i.e., pipelines).

The above chart shows the history of investment in Equipment and Intellectual Property products (notably software and tech). The IP line is steady business across cycles and moved ahead of Equipment the past cycle. The smooth, rising line of IP speaks for itself across the last few cycles.

Some big variables from here on the Equipment line ties into the topic of trade, reestablishing geopolitically safe supplier chains, tariff policies to encourage reshoring/nearshoring, and where policies out of Washington can support a more rapid pace for that trend. The rise of Electric Vehicles, battery manufacturing facilities and a range of “transition” categories offer upside. The protectionist trends are here to stay, and that could create a long checklist of pros and cons running through the Equipment and Structures lines.

There are more than a few who believe the World Trade Organization faces existential threats in coming years on the need to protect and expand the US industrial base and start to rebuild manufacturing. The trick will be managing the fight with China while making sure Europe does not wade into a trade battle with the US as well. There is also the rule of the road in NAFTA and how those investment plans play out across free trade agreement borders.