Bullish & Bearish In U.S. GDP Report
More interesting was the revision. As I predicted yesterday, it did indeed downwardly revise growth in 2004-2006. 2004 was revised down to 3.6% from 3.9%, 2005 to 3.1% from 3.2% and 2006 to 2.9% from 3.3%. Inflation was on the other hand upwardly revised, but not by as much as the downward revision to real growth, so nominal growth was also downwardly revised. The related measures of GNP (GDP plus net factor income) and national income (In principle GNP minus capital consumption, but in practice it also includes a statistical discrepancy as its data come from other sources).
But the most interesting aspect of the revision was the change of distribution within national income. This revision implies a somewhat more bullish outlook for private consumption than I outlined yesterday, but it also implies a much more bearish outlook for business investments.
The bullish news from the revision was that disposable income was upwardly revised even as consumer spending was downwardly revised. As a result, the savings rate was actually +0.6% instead of the -1% to -1.5% one could have expected from the unrevised April and May numbers. While there was a small upward revision to compensation of labor, the main reason for the upward revision of personal income was much higher dividend income. That the savings rate is positive rather than negative, if only slightly, means that consumer spending now seems less vulnerable to falling house prices.
The really bearish news was the downward revision to corporate profits. And with dividend payments upwardly revised, that of course also implies that retained earnings was even more downwardly revised. As a result of the downward revision to profits and upward revision of dividend payments, retained earnings in the first quarter of 2007 fell to their lowest level since 2003 (except for the special case of Q4 2004 when Microsoft's special dividend depressed the number) in nominal dollars. You have to go back all the way to the recession year of 2001 to find retained earnings at a lower share of national income. Including dividends, corporate profits aren't fully as weak. But even including dividends, domestic corporate profits were at their lowest share of national income since 2004 (except for the third quarter of 2005, when Katrina related damages depressed it). And I expect profits for the second quarter to be even lower.
The decline in profitability and the weaker cash flow implies that it seems unlikely that corporate executives will really find it profitable to increase investments significantly, especially with the weakness in domestic demand. For this reason, it seems likely that the decline in investment goods demand implied by the durable goods report yesterday was not an anomaly, and that business investments will be stagnant or even negative.
All in all, the report does not significantly strengthen or weaken the bearish case as the more bullish outlook for consumer spending is cancelled out by the more bearish outlook for business investments. Ultimately though, as business investments is what builds the productive capacity, the supply side of the economy, the more bearish case for investments is more important than the more bullish case for consumption-particularly in the long term.