May 2013

A PUBLICATION OF CHILTON CAPITAL MANAGEMENT

WWW.CHILTONCAPITAL.COM

Cutting to the Core

Samuel Rines
n many ways, the Bureau of Economic Analysis latest GDP report mirrored many of the releases since the end of the Great Recession. For the first quarter of 2013, the US economy grew at an annual rate of 2.5 percenta positive number, but not positive enough to provide a significant lift to employment levels. Economists predicted more robust growth, but it failed to materialize, and it seems as though every time the economy is about to lift off, something goes awry. The mediocre growth trend that continues to dominate the headlines is deceiving though. Growth from the Core At 71 or so percent of GDP, the US economy is dominated by the consumer. But personal consumption expenditures are often overshadowed by less meaningful and more volatile components of GDP. For perspective, personal consumption expenditures have been positive and consistent since the beginning of 2010, contributing an average of 1.62 percent to GDP growth per quarter. The average contribution from 2000 through 2007 was slightly above 2 percent with the median nearly identical1.72 for 2010 to present compared to 1.75 for 2000 through 2007. Residential fixed investment has also begun to tick up with growth beginning to move the needlesomewhatfollowing the housing starts and new home sales data. Though a high unemployment rate may obscure it, consumers have been alive and well in the economy since the end of the recession.

The most consistent drag in the economy is the federal, state, and local government spending which makes up about 18.5 percent of GDP. From 2000 through 2007 government consumption and investment contributed an average of a positive .37 percent to GDP. But from 2010 through the latest report, government has subtracted an average of .46 percent every quarter. Change in private inventories can be even more volatile and impactful. For example, in the fourth quarter of 2012, this lesser known component of GDP subtracted 1.52 percent from economic growth. Then, in the first quarter of 2013 it added 1.03 percent. The core of economic growth in the US is personal consumption, and the consumer has been healthy since the end of the recession. Distortions in the data sometime make it difficult to see the underlying strengths in the economy. But this is not the only issue with understanding the ebbs and f lows of the economy. Sometimes the problem is the data itself. Accuracy Lacking Consider GDP for the fourth quarter of 2012; which was initially reported as a negative .1 percent but then revised to a positive .4 percent. This figure will be revised again, and there will be a revision of that revision. Eventually (many years from now), the revisions will cease, the numbers will settle, and very few people will ever look at them. These revisions can be significant. They can change growth from negative to positive, and even possibly have policy implications. According to the BEA, the average change from the advance estimate to the latest estimate is .3 percent (latest being synonymous with final until re-revised).

Counting More Beans And there is about to be more data to revise. To improve the capture of information and provide a clearer picture of the drivers of growth, the BEA is going to add a couple new lines to the GDP release at the end of July. Additions will include research and development expenditures along with other intellectual property items. Creative works such as books, movies, and music will be counted along with the output of nonprofit institutions. This should instantly boost GDP by about 2 percent ($300 billion), though since the additional lines of data will be added back to 1929, it should not have an effect on the actual growth rate. Nonetheless it will modernize an aging system, allowing for a clearer picture of what a 21st century economy actually looks like. R&D is a Growth DriverFor China R&D is a pivotal component of the modern economy encompassing the money spent to develop everything from pharmaceuticals to aerospace technology. At $420 billion, no one spends more on R&D than the US. In a $16 trillion economy however, this equates to around 2.66 percent of GDP. And growing at less than 1 percent annually (or about $5 billion), the inclusion of R&D will provide an increase in GDP of about .03 percent. Compare this to China, which, like the US, does not currently count R&D, at least directly, in its GDP numbers. But China is growing R&D rapidly. The National Bureau of Statistics published a report stating R&D spending increased by 17.9 percent in 2012 to $197 billion. Private numbers have this figure closer to 11.5 percent, but it is impressive either way. If Chinas investments in R&D continue at a similar pace, the $197 billion would grow to around $220 billion or by about $20 billion. With an $8.5 trilliongive or takeeconomy, this $20 billion would boost the reported growth rate in China by .20 to .25 percent. And this growth is unlikely to diminish in the near future as China continues to stress R&D investment.

are far less significant than the US consumer. Adding R&D to the GDP report will be an interesting exercise, but will not drastically change the headline numbers as the US continues to reduce the share of GDP dedicated to R&D. China, on the other hand, would benefit from the addition of R&D as the government continues to stress the investment, and its inclusion would push growth rates higher. While China continues its attempt to shift the core of the economy away from exports to consumption and higher value added manufacturing, it would be prudent for them to follow the US and add R&D. But little is going to change for the US. It will always be necessary to take a close look at the data to be certain there the distortions are not distracting from the core.
Sources: Commerce Department, Bureau of Labor Statistics; St. Louis Federal Reserve Economic Database, R&D Magazine, International Monetary Fund, National Bureau of Statistics of China

SAMUEL RINES is an A nalyst and Economist at Chilton Capital M anagement in Houston, Texas. direct questions or comments to: srines @chiltoncapital .com ZACH BECK is the E ditor of Chilton Currents and an Operations Specialist at Chilton Capital M anagement in Houston, Texas. For further information on Chilton Capital M anagement strategies and services, please contact Christopher L. K napp, cknapp@chiltoncapital .com For reprints contact srines@chiltoncapital .com www.chiltoncapital .com/currents

With an $8.5 trilliongive or take economy, this $20 billion would boost the reported growth rate in China by .20 to .25 percent.
Through the Trees Understanding how the core of the US economy is performing is pivotal to being able to overlook the distortion surrounding it. Government and inventories should not be ignored, but they