Geez 2 threads on the topic pigged before I can get to it, busy wrtting it up for Zacks.com. Here is what I am going to be posting there, warning its pretty long:

Percent Changes by Major Category

In the second quarter GDP fell at an annual rate of 1.0%, better than consensus expectations of a 1.5% drop (and my own expectation of down about 2.0%). However, the first quarter was revised to a decline of 6.4% from a decline of 5.5%. This was a surprise since the previous two revisions had been in the direction of a smaller decline.

Consumption: Negative after being positive

The consumer was actually weaker in the second quarter than in the first, with personal consumption expenditures (PCE) falling 1.2% vs. a rise of 0.6% in the first quarter (org. up 1.4%). The swing in goods particularly durable goods was large, with a decline of 4.0% vs. an increase of 2.5% in the first quarter for all goods and a decline of 7.1% vs. an increase of 3.9% in the first quarter for Durable Goods. Non Durable goods declined 2.5% vs. an increase of 1.9%. Services, which is the biggest part of PCE went the other direction with a gain of 0.1% vs. a 0.3% decline in the first quarter. Since PCE is such a huge part of overall GDP, it is surprising to see a very significant deterioration in it coincide with a substantial improvement (less negative) in overall GDP growth.

Investment: Awful, but not as big a disaster as first Quarter

The main reason for the better performance was that Investment was just very bad, not the unmitigated disaster that was the first quarter. Total Gross Private Domestic Investment (GPDI) fell “only” 20.4% vs. a 50.5% decline in the first quarter (org. 48.9%). GPDI is split into Residential and Non-residential as far as fixed (non inventory) investment is concerned. Fixed investment fell 13.8% following a 39.0% decline in the first quarter. Residential was down 29.3% following a 38.2% decline in the first quarter. In the third quarter that will probably change and we may actually see a small positive. On the Non-Residential (a.k.a. business) side, investment is broken down into Structures and Equipment & Software (E&S). Total business investment was down 8.9% following a 39.2% decline in the first quarter (org. -37.3). Investment in structures declined at only an 8.9% rate following a 43.6% plunge in the first quarter (org -42.9). This was much better than I expected, and I suspect is not sustainable given the massive oversupply of office buildings and stores. Rents and values are falling as vacancies rise. I suspect that we will see a bigger decline in this area in the third quarter. Investment in E&S declined at a 9.0% annualized rate following a 36.4% plunge in the first quarter (org. -33.7%). Investment is always the biggest swing factor in the economy, and while under normal circumstances a 20.4% decline in investment would be awful, coming off the 50.5% decline in the first quarter it feels pretty good. Sort of like the difference between smacking yourself in the head with a wiffle ball bat rather than a baseball bat.

Net Exports: A smaller net positive as both fall less

Net exports were less of a story than they were in the first quarter, but were still a help. Both imports and exports were down, but our imports fell more so that is considered a positive for GDP. Imports fell at an annualize rate of 15.1%, much less than the 36.4% decline in the first quarter. Given the decline in PCE, it does not look like a lot of that represents just a reflection of lower overall demand rather than people substituting domestic goods for imported ones. Thus we are in a sense exporting our downturn to the rest of the world. Not that it is a one way street as our exports fell at 7.0% following a 29.9% decline in the first quarter. Still 7.0% is a lot smaller than 15.1%, and it is from a much smaller base tat our imports. This is not exactly news given the massive decline we have seen in the monthly trade deficit numbers.

Government: Helps rather than hurts, mostly defense

The government was a big help to the economy in the second quarter (one can debate the long term consequences of that, but for the second quarter it sure helped) with an overall increase of 5.6%. It was mostly the Federal government with a 10.9% increase, and most of that went into Defense with a 13.3% increase. Non defense Federal spending rose by an annualized 6.0% rate. This is a marked turnaround from the first quarter when over all government spending fell 2.6% (org. 3.1%). Within that in the first quarter defense spending fell 5.1% and non-defense fell 2.5% in the first quarter. State and Local spending saw a similar, if smaller swing rising 2.4% after a 1.5% fall in the first quarter (org -2.2%). The swing particularly in the S&L and non-defense spending is most likely related to the stimulus bill. That spending is still ramping up so may provide a bigger boost in the second half. On the other hand S&L tax collections have been under enormous pressure and those governments can not do deficit spending (although there are some games that they can play that allow for effectively some S&L deficit spending). Keep in mind that the government figures do not include transfer payments like Social Security of Medicare (they show up in the PCE numbers).

Contributions to Growth (or contraction)

Since not all the elements of GDP are the same size, they don’t have the same impact on overall GDP growth, thus it is useful too look at the point contribution to the -1.0 overall decline in the second quarter and the -6.4% decline in the first quarter. PCE was a big negative swing factor, subtracting 0.88 points (or nearly the entire GDP decline by itself) while in the first quarter, PCE offset other parts of the economy contracting to the tune of 0.44 points. Within PCE more than all of it was in Goods, with overall goods falling subtracting 0.92 points split between a 0.52 drag from durable goods and a 0.40 decline due to non durable goods. In the first quarter goods added 0.56 points to GDP growth, evenly split between 0.28 gains in both durable and non durable goods. PCE on services was a very small offset, adding 0.04 points in the second quarter after being a 0.13 point drag in the first quarter.

The smaller drag from GPDI was by far the biggest reason for the sequential improvement, subtracting “only 2.64” points from growth rather than the 8.98 point drag in the first quarter. Inventory investment (liquidation) was a 0.83 point drag on growth (part of the 2.64) which was a much lower drag than the 2.36 point drag in the first quarter. Generally if GDP is weak, inventory investment is where you would want to see it, as big changes in inventories have a habit of being reversed in future quarters. The subtraction from inventories was almost as big as the subtraction from overall PCE. While the decline in PCE may be welcome from a long term structural point of view (i.e. moving our economy more in the direction of investment and exports, rather than consumerism) it is also more likely to persist than a decline due to inventories. Fixed investment was also still a substantial drag on the economy, subtracting 1.82 points. However it was a huge improvement over the 6.62 point drag in the first quarter.

Residential investment (mostly homebuilding) subtracted 0.88 growth points, down from a 1.33 point subtraction in the first quarter. This was the 14th straight quarter in which residential investment subtracted from economic growth. The 0.88 point drag was just slightly less than the 0.97 average drag over the prior 13 quarters. However, residential investment is getting to be a smaller and smaller part of overall GDP, and it is not going to go to zero. Looking forward we might actually see a small positive from this category in the third and fourth quarters.

Non-Residential Fixed investment was a 0.94 point drag on the economy, but that was a massive improvement over the 5.29 point drag in the first quarter. Investment in equipment and software subtracted 0.59 of those points. Investment in structures subtracted 0.34 points. On both fronts a massive improvement over the 2.28 point drag from structures and the 3.01 point drag from E&S in the first quarter. I suspect that the reduced drag from business investment, particularly in structures is temporary and will be a bigger problem in the third quarter. Unemployment means companies have empty cubicles, so why build more office buildings. There are closed stores all over the place, so why build a new strip mall? Capacity utilization is at a record low by a long shot, so why buy more machinery when the stuff you have is sitting idle. The software side of E&S will probably fare better than the equipment side, since often software can be a cost cutting investment rather than a capacity expansion investment (both can be either, but increased equipment investment is more likely to be about expanding capacity than about cutting costs).

The contribution from Net Exports was a 1.38 point gain, or offset to declines elsewhere in the economy. This happened as our reduced imports added 2.14 growth points but the fall in exports was a 0.76 point drag to overall growth. Both the change in imports and exports were less significant than in the first quarter when plunging imports was a huge offset to the rest of the economy being weak, adding 6.58 points. Think about that for a moment. If our imports had not fallen in the first quarter, or economy would have been plunging at an annualized rate of almost 13.0%. In the first quarter though, the drop in our exports subtracted 3.95 points, so if we had been able to keep our exports up (and held everything else constant) the first quarter decline would have only been -2.45%. Netting them out, trade helped grow (offset the contraction elsewhere) the economy by 2.63 points in the first quarter. Thus, trade was less of an offset (1.38 point positive) in the second quarter than it was in the first quarter by 1.25 points.

Government spending helped boost the economy by 1.12 points, with S&L governments contribution 0.30 points and the federal government adding 0.82 points, of which 0.67 points came from defense spending and only 0.15 points came from non defense spending. In the third and fourth quarters I would expect a much larger contribution from Federal spending, particularly non defense spending as the stimulus package kicks into high gear. This might be offset by S&L weakness as states are forced to cut back, as California is doing in a rather spectacular way. Most other states face similar, but not as large problems.

Overall though this is a very impressive improvement. Just a few months ago it looked like we were in a self sustaining vicious circle of lower demand leading to layoffs and yet further lower demand. Now it looks as if confidence has been restored and the economy is getting its footing. The improvement in net exports is probably sustainable, although I would sure like it more if it were based on exports rising more than imports rather than imports falling more than exports, the arithmetic is the same for the GDP numbers. However, a big part of the improvement in trade in both quarters was lower oil prices. That part is not likely to be repeated. If residential investment is just at 0.0% in the third quarter it will be a big help to the overall GDP numbers. Inventories are likely to swing from being a drag on growth to being a positive for growth, and possibly a very significant one. One area to watch will be the rebuilding of auto inventories. Increases in production at Ford (F), Toyota (TM) and Honda (HMC) as well as at still non-big board traded GM and Chrysler are likely to add to growth. The cash for clunkers was a big success in clearing the lots (so much so it ran out of money almost immediately but is likely to get reloaded). Not that I am expecting auto sales to return to the levels of a few years ago anytime soon, but going from an annual sales rate of just over 9 million a year to 12 million a year is a substantial percentage increase, swinging from being a negative to being a positive for growth.

These are the signs one generally sees in the early stages of an economic recovery. I still think it is going to be a weak recovery and not enough to bring down unemployment anytime soon. To get unemployment to fall we need to generate growth of about 2.0%. However, one can see a path towards an actual positive print on GDP growth in the third quarter. I’m not sure if it will happen, or if we have to wait until the fourth quarter to get that positive number, as I think the drag from non-residential fixed investment, particularly in structures could slip to being a bigger negative in the second half. However, it is a very real possibility.