Beyond the Indicators: When Good News Isn't: Brusca
On Friday something interesting happened in the markets.
The U.S. stock market was said to have risen because of a good U.S. trade report that showed a smaller deficit that likely would propel gross domestic product into a revision causing it to post a positive growth number in 2012's fourth quarter instead of a tiny negative one.
Now that's good news isn't it?
Well, yes it is…yes but…
In taking the trade report apart we encounter something I like to call the paradox of trade. A paradox is a statement or argument that results in an inconsistency. And that is exactly what we got in the trade report.
Here it is: Since the U.S. trade deficit shrank sharply in December there will be a smaller subtraction from GDP (we will subtract a smaller number from GDP since trade is in a deficit position and the deficit is smaller).
The new estimate for the deficit is smaller than what had been anticipated when the preliminary estimate of GDP for Q4 was constructed. Because of this GDP will be higher and its growth rate will be stronger. GDP, based on this one bit of data, probably will no longer show negative growth in Q4.
That's the good news.
Here is the bad news. U.S. imports are weak. And imports are closely linked to GDP. Weak imports suggest that there will be more weak GDP reports to come. That is bad news and it is the kind of bad news that trumps the good news.
(Read More: Why This Is 'Best-Looking' GDP Drop You'll Ever See)
The paradox is that when GDP is weak imports fall and falling imports make GDP stronger. But since GDP is what we are most interested in, the real news is in what GDP is doing, not what the 'feed-back' effect is. The 'feed-back' effect from trade through imports always damps the move by GDP. That's just how it works.
The U.S. trade report for December contracted by about $10 billion in one month; that has only happened twice in the last 20 years and both episodes were in the last recession during quarters when GDP fell very sharply.
That is not a good precedent.
Imports fell in December 2012 and imports are falling over three-months, over 6-months and over 12-months. The drop is not a fluke. More worrisome, it's part of a trend. And, since import growth is linked tightly to GDP growth, that is not a good development at all.
And it's not just caused by some special event like oil imports.
In real terms non petroleum imports fell in December and are declining over three-months and getting progressively weaker over the last year. Exports are weakening too and real non-petroleum exports (the U.S. does export some petroleum product-so we look at exports fee of this 'distortion') are declining over three-months and six months.
(Read More: Exactly How Skewed Is China's Trade Data?)
So you can see where I am going with this.
The trade report produced a minor bit of good news for those that hang on each quarterly GDP report (perhaps the folks that hang on quarterly corporate profit reports? …and like to look at the water that goes under the bridge or cry over spilled milk?) But in big broad terms the message from the trade report that has meaning for the future is that both exports and imports are on weakening trends. Moreover, sharp contractions in the trade deficit are more often signs of bad things in train for GDP than good things.
In their GDP account incarnation real exports and imports are down to nearly zero growth over four-quarters. There are no recent examples of exports and imports both contracting in real terms over a one-year period and the U.S. economy not being in recession.
The R-squared relationship between year-over-year growth rates in real GDP and real imports is 0.78, quite high. While lower imports (lower than expected) might juice GDP this quarter the general trend for lower imports is not consistent with continuing GDP growth. Imports generally grow about 2.5 times FASTER than GDP.
So you can see what zero growth or negative growth in imports implies for GDP growth.
The world economic condition makes it unlikely that U.S. exports are going to find much life to stimulate GDP.
We already have accompanying signs of weakness from other domestic variables. There is very weak and recently plunging consumer confidence and sentiment. The regional manufacturing readings from the Federal Reserve district banks are very weak. The national Institute for Supply Management's are firmer than the regional Fed indices partly because their job components are so strong.
But jobs are a lagging, not a leading, indicator.
If the national MFG Purchasing Managers Index and the Non-MFG PMI are being held higher because of their job readings (as they are…) surely that is not really a good sign.
There are lots of signals out there. Different people emphasize different indicators. And many of the signals contradict other signals. But many of them are weak and some of them are misunderstood. Few are truly strong. The Friday signal from the trade report was misunderstood by the markets. There was nothing in the trade report that I would regard as good news. When GDP is so weak that it causes imports to contract, thereby improving the trade deficit, that is an unambiguous bad event-not a mixed signal. But it can be misread when the paradox of trade is not well understood.
Whatever you do, do not mistake bad news for good.
Robert A. Brusca is Chief Economist of Fact and Opinion Economics, a consulting firm he founded in Manhattan Mr Brusca has been an economist on Wall Street for over 25 years. He has visited central banking and large institutional clients in over 30 countries in his career as an economist. Mr. Brusca was a Divisional Research Chief at the Federal Reserve Bank of NY (Chief of the International Financial Markets Division), a Fed Watcher at Irving Trust and Chief Economist at Nikko Securities International (for 16 years). Mr Brusca currently is a consultant.