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Posted April 29, 2022

Sean Ring

By Sean Ring

GDP Tanks; Philly Fed Warned Us

  • In Q1 of 2022, US GDP contracted 1.4%.
  • Its a sharp contraction after 2021 Q4 posted a 6.9% increase.
  • The leading indicator, Philly Fed Index, warned us last week.

Happy Friday!

First coffee, then perhaps a nice bottle of Grignolino later.

I usually like to write a light, fluffy Rude on a Friday, but thats not happening today.

With the help of my paisano Mark Rossano, Im going to break down the awful GDP numbers from yesterday and the Philly Fed Index, a leading economic indicator that showed weakness last week.

Theres no surprise to me the economys contracting.

The shock is that it came through in the numbers so quickly.

As you know, governments love to massage numbers in any positive way they can.

But this time, the scary truth wouldnt be denied.

Were in a spot of bother.

Chairman Powells butt cheeks probably clenched so hard on the news, he couldve turned a hunk of coal into a diamond.

Lets look at the GDP number first.

GDP Contracts (Un)Expectedly

Before I get into the number itself, know that GDP is a flawed metric.

That it makes spending synonymous with output gives you a great headstart on why it may not be the best measure of an economys strength.

Keynesians define GDP by the ubiquitous equation GDP = C + I + G + (X - M).

That is, Gross Domestic Product equals consumption plus business investment plus government expenditure plus exports minus imports.

So if government spending increases, GDP increases.

This is ludicrous because the government doesnt earn anything by selling goods and services.

Government is a gigantic parasite spending money the private sector has already made.

Nevertheless, everyone uses it, so we will.

From the Bureau of Economic Analysis itself (bolds mine):

The decrease in real GDP reflected decreases in private inventory investment, exports, federal government spending, and state and local government spending, while imports, which are a subtraction in the calculation of GDP, increased. Personal consumption expenditures (PCE), nonresidential fixed investment, and residential fixed investment increased.

Credit: Bureau of Economic Analysis

The inventory numbers are horrible because companies cant replace their products due to government-induced inflation and supply chain idiocy.

And unfortunately, while I cheer any federal, state, and local government spending decrease, perversely, this is a negative for GDP.

But as our friends at Capital Economics noted, since PCE was up, this probably wont stop Chairman Powell from raising rates 50 basis points (0.50%) at the next Fed meeting.

Yes, I think rates need to go up. Way up.

But if Powell wants to have his soft landing, he needs to reconsider how he accomplishes this.

For some private sector confirmation of the current economic woes, Amazon (AMZN) posted its first loss since 2015.

From the WSJ (bolds mine): Inc. AMZN 4.65% posted its first quarterly loss in seven years, a result that reflected broad economic trends related to a slump in online shopping, higher costs from inflation and supply-chain woes, and market jitters over electric vehicle startups.

It lost $3.8 billion in the quarter, compared with a profit of $8.1 billion a year ago, when a surge in online orders due to the pandemic lifted Amazons prospects.

In the next section, I will turn our attention to the Philly Fed Index and how it accurately - and very quickly - foretold this GDP ugliness.

A big thank you goes to the Sherlock of the Supply Chain, Mark Rossano, whose cerebral firehose I turned into an understandable (I hope) trickle.

Seeing Ahead With the Philly Fed

Last Thursday, the Philly Fed reported a pretty alarming number, though not a recessionary one.

Whats the Philly Fed?

The Philly Fed is a leading economic indicator, which gives us an idea of what direction the region, and by extension, the country, is going.

The Philly Fed, technically called The Manufacturing Business Outlook Survey, is a monthly survey of manufacturers in the Third Federal Reserve District.

The Third Federal Reserve District covers the state of Delaware, nine counties in southern New Jersey, and 48 counties in the eastern two-thirds of Pennsylvania.

Credit: Investopedia

Participants indicate the direction of change in overall business activity and the various activity measures at their plants: employment, working hours, new and unfilled orders, shipments, inventories, delivery times, prices paid, and prices received.

The survey has been conducted each month since May 1968.

How Do We Interpret It?

When the Philly Fed is above zero, it indicates factory-sector growth. When its below zero, it implies contraction.

Whats the Overall Outlook?

The summary index missed estimates and came in at 17.6 instead of the expected consensus of 21.4. Its still technically in expansion territory.

But the pressure to the downside is mounting, driven by inflationary pressures and softening expectations.

As companies become more concerned about the future, they will quickly adjust their spending, investment, and hiring to ensure enough cash reserves to make it through the lean periods.

After the summary number, we look at three leading indicators: Prices Paid, Business Activity, and Expected New Orders.

Prices Paid

Prices paid is best defined as costs to the company.

How much did you spend on raw materials?

Are the prices rising or falling?

What did it cost for electricity, labor, and other factory gate prices?

When a company sets its price for consumers, it looks at the cost of making or assembling the product, figures out its margin, and gets what the price will be on the shelf.

Prices paid is a LEADING indicator for the CPI (Consumer Price Index) and helps define where inflation will be over the coming few months.

It is breaking out higher to a new record, just as we get renewed supply chain issues and broad logistical nightmares created by trucking and China lockdowns.

Companies will try to pass through as much of this new cost as possible - until the consumer rejects the price increases.

Consumers can either reduce total quantities due to price, find a replacement product, or not buy anything.

As this occurs, companies are forced to reduce their margin and keep prices reduced, hoping to at least cover costs.

This is when the pain really bleeds into the economy and we are getting there.

Six Month Outlook: Business Activity

Confirmation of that view comes in the 6-month outlook of business activity.

What do they expect their activity to be?

You wont be surprised to know they expect a lot of pain ahead and will be hiring, constructing their inventory, and operating their business along that line.

Its a pretty staggering dip from the previous highs.

New Orders

New orders are the last one that helps dictate hiring and what needs to be purchased for inventory.

New orders are getting crushed as consumers and businesses pull back on spending.

Again, were above zero, but not by much!

Wrap Up

The dire economic numbers are already filtering through.

The unexpected GDP hit was coming. We just didnt think itd be this soon.

Amazons earnings hit is also indicative of the overall macro environment.

The Philly Fed is a great leading economic indicator.

If it stays above zero, were growing. If not, were shrinking.

Right now, we seem to be on the precipice of a contraction.

Thanks to Bidens inflation, prices paid are up, while business activity and new orders are getting hammered.

Its a macro world now, and weve got to live in it.

In the meantime, have a wonderful weekend.

All the best,


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