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Craig Allen: Chance of Recession Will Increase If GDP ‘Second Estimate’ Shows Weakness

On April 30, the Bureau of Economic Analysis (BEA) released the “advanced” U.S. real gross domestic product (GDP) report — the output of goods and services produced by labor and property located in the United States.

This report showed that GDP increased at an annual rate of 0.1 percent in the first quarter (that is, from the fourth quarter of 2013 to the first quarter of 2014). In the fourth quarter, real GDP increased 2.6 percent.

The “second” GDP estimate will be released this week, on Thursday. If this revised estimate of GDP should fall to a negative value, it could pave the way for serious speculation regarding the possibility of a recession for the U.S. economy.

The official definition of a recession is two consecutive quarters of negative GDP growth. Admittedly the economy would have to experience significant weakness in many data series to result in negative GDP growth in the second quarter. Improvement in employment has appeared solid, with the unemployment rate falling to 6.3 percent in April from 6.7 percent the previous month, and new jobs growing by 288,000. While this pace is not robust, it is certainly not recessionary.

The BEA emphasizes that the advance estimate for GDP growth is based on source data that are incomplete or that are subject to further revision by the source agency. The “second” estimate will be based on more complete data. There will be a third and final revision, which will come in late June.

Although fourth quarter 2013 GDP growth was 2.6 percent annualized, there were some significant challenges during the quarter, the results of which spilled over into the first quarter, and could help explain why the first quarter’s growth was so weak. These include severe weather, a relatively weak brick-and-mortar holiday selling season and the effects of Obamacare on business spending.

According to the BEA, the deceleration in real GDP growth in the first quarter primarily reflected downturns in exports and in nonresidential fixed investment, a larger decrease in private inventory investment, a deceleration in personal consumption expenditures, and a downturn in state and local government spending that was partly offset by an upturn in federal government spending and a downturn in imports.

As we look ahead to the second estimate of first quarter 2014 GDP, the BEA’s estimates typically are revised, from the advance estimate to the second estimate (one month later), by on average, without regard to sign, by 0.5 percentage points, while from the advance estimate to the third estimate (two months later), the average revision is 0.6 percentage points. From the advance estimate to the latest estimate, the average revision, without regard to sign, is 1.3 percentage points. The average revision (with regard to sign) from the advance estimate to the latest estimate is 0.3 percentage points, which is larger than the average revisions from the advance estimate to the second or to the third estimates.

The two things that are important to watch for this week with regard to the second GDP report for first quarter GDP growth will be:

» A revision from the advanced estimate of 0.1 percent growth to a negative growth value

» A revision, especially one to the downside, of more than the 0.5 percentage point average

Should first-quarter GDP slide to a negative value, and especially if that negative value is significantly lower, speculation will run rampant that the U.S. economy is headed for a recession.

While I believe the chances for a recession are low (again the official definition is two consecutive quarters of negative GDP growth), the mere suggestion of the possibility of a recession in the data could be enough to seriously threaten the ongoing recovery and, more important, could serve as a trigger to send stocks into a sizable correction or even a crash.

A negative GDP result for the first quarter in this week’s report could help assuage fears about the Fed beginning to ratchet up interest rates early next year. However, it could also pressure the Fed to slow or even stop its removal of stimulus — the current $45 billion per month bond-buying program the Fed has been weaning the economy off of since the beginning of the year at $10 billion less each month.

Should the Fed be forced to back away from the current pace of stimulus reduction, it would send a very strong message that the Fed is losing faith in the recovery, which could certainly rattle global financial markets.

This week’s second estimate for first-quarter GDP growth will most likely be benign. If it is revised up a few tenths of a percentage, the report will very likely have little, if any, impact on anything.

My purpose in laying out this unlikely scenario is not to warn you about a possible negative report on GDP, but to point out that something/anything like this report can be a trigger that sets off a series of outcomes that can directly affect each and every one of us. Such is the inherent risk in a five-year plus economic recovery with a stock market at all-time highs.

Craig Allen, CFA, CFP, CIMA, is president of Montecito Private Asset Management LLC and founder of Dump That Debt. He has been managing assets for foundations, corporations and high-net worth individuals for more than 20 years and is a Chartered Financial Analyst (CFA charter holder), a Certified Financial Planner (CFP) and holds the Certified Investment Management Analyst (CIMA) certification. He blogs at Finance With Craig Allen and can be contacted at .(JavaScript must be enabled to view this email address) or 805.898.1400. Click here to read previous columns or follow him on Twitter: @MPAMCraig. The opinions expressed are his own.

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