Your Tuesday Data Delight

August—that interminable slow financial news month—is finally ending, and economic record keepers globally went out with a bang. Tuesday brought an avalanche of data, running the gamut from Chilean unemployment (improving to 8.9% in July) to Slovenian gross domestic product (accelerating from 1.7% y/y to 16.3% in Q2).^[i] (Gross domestic product, or GDP, is a government-produced measure of economic output.) There were also some interesting nuggets from nations that play large roles in global developed equity markets, so let us bring you the two we found most interesting.

Is Germany causing a eurozone inflation headache?

The eurozone released preliminary August inflation today, and several financial commentators we follow described the acceleration from 2.2% y/y to 3.0% (versus expectations for 2.7%) as a “shock.”^[ii] Shouldering much of the blame was Germany, which announced yesterday that inflation hit 3.4% y/y when using the standard EU calculation and 3.9% using the Federal Statistics Office’s standard approach.^[iii] Many analysts we follow pointed to the country’s well-documented supply chain issues, which are starting to hamper factory output in some industries—driving prices higher as customers compete for a limited supply of goods. With no end to these issues in sight, they argue, it is no longer fair to call higher inflation “transitory,” which is the word monetary policy institutions like the European Central Bank (ECB) use frequently to describe economic developments they don’t think are likely to last.

In our view, the common interpretation of these inflation data is likely too hasty. “Transitory” doesn’t mean here today, gone tomorrow. It means temporary. Similarly, shortages don’t automatically mean prices keep rising month in, month out. Take Germany’s auto industry, for example. According to much of the coverage we encountered, several plants cut shifts due to the shortage of semiconductors, spurring large drops in vehicle deliveries for some companies. Hypothetically speaking, if production were to hover around July levels for the next year or two until new semiconductor foundries come online and increase the global supply, is that going to have an exponential effect on prices? Or might prices find a new equilibrium at the lower production level? Basic economic theory would suggest the latter. One-time increases stay in the year-over-year calculation for a while because of math, but eventually they fall out, and the inflation rate generally moderates.

Now, this is of course an all else equal theoretical argument, and all else is never equal. But the US has already shown that extrapolating huge supply-driven price increases forward is an error. As the aforementioned semiconductor shortage hit the supply of new autos there, people turned to the used auto lot. That heightened demand quickly burned through much of the available supply, driving prices higher. The used autos and trucks component of the US Consumer Price Index (CPI, a government-produced measure of prices across the economy) rose 10.0% m/m in April, 7.3% in May and 10.5% in June.^[iv] But in July, used car prices stabilised, rising just 0.2% m/m.^[v] The year-over-year rate was a whopping 41.7% due to the cumulative effect of springtime price hikes, but that was a legacy effect, not a new price pressure.^[vi] This is one small category in one country, but in our view, it illustrates the broader concept well.

Supply chain issues that affect prices for a few months are real and pinch all of our pocketbooks, but we don’t think they qualify as actual inflation. Big price increases in select goods jump out, but inflation involves prices increasing across the entire economy, generally hitting goods and services alike. We think it is also a monetary phenomenon—too much money chasing too few goods and pushing prices higher steadily over a long stretch. That is what we saw in the 1970s, according to our research. That is the sort of thing a monetary policy institution like the ECB or Bank of England can curb with its standard toolkit, in our view. But we think a consumer price index skewed by temporary shortages of a handful of goods likely isn’t in monetary authorities’ power to fix.

Oh Canada, Where Did Your Exports Go?

Canadian GDP seemingly delivered an even bigger shock to many observers. Economists’ consensus expectations, as tabulated by FactSet, were for 2.5% annualised growth in Q2, a solid—if unspectacular—figure. (The annualised growth rate refers to the rate GDP would grow over an entire year if the quarter-on-quarter growth rate persisted all four quarters.) Instead, GDP declined -1.1% annualised, putting the recovery from last year’s recession on pause and spurring much handwringing amongst the Canadian commentators we follow.^[vii]

We found the underlying details rather interesting. Household spending grew just 0.2% annualised, as a -7.0% drop in spending on goods largely cancelled out a 7.3% jump in spending on services.^[viii] Business investment was similarly split. It fell -2.2% annualised as a -12.4% drop in residential construction erased a 12.1% rise in commercial real estate, machinery and intellectual property products.^[ix] On the public side of the ledger, government spending rose 6.1% annualised but investment fell -7.7% as some COVID-related endeavours phased out.^[x] Crucially, however, none of this explains GDP’s contraction or the big surprise. Total spending contributed 3.1 percentage points to headline GDP, whilst total investment detracted just -0.7 percentage point.^[xi] If those categories were all there is, Canadian GDP would have grown.

Which brings us to the real culprit: Exports. Those fell -15.0% annualised, subtracting 4.7 percentage points from headline GDP.^[xii] Services exports grew 4.6%, but goods exports fell an astounding -18.3%.^[xiii] That doesn’t come close to squaring up with the monthly trade reports, which showed exports falling -0.5% m/m in April and -1.9% in May before soaring 8.7% in June.^[xiv] If you calculate quarterly growth manually using the monthly totals, you get a 0.8% q/q increase or 3.4% annualised.^[xv]

The gap, as best we can tell from looking at all the numbers and reading the entirety of Statistics Canada’s methodology materials (you’re welcome), is due to the inflation adjustment. On a nominal (i.e., not adjusted for inflation) basis, goods exports rose 0.6% q/q and 2.5% annualised in Q2, which is much more in line with the monthly data.^[xvi] Canadian monthly trade data are seasonally adjusted but not inflation adjusted, much like their global counterparts. According to Statistics Canada’s press release, export prices rose 4.9% q/q in Q2, which apparently was enough to result in a massively negative inflation adjustment.

But in our view, this isn’t really a negative development. Rather, it means Canadian producers have decent pricing power, which helps protect profit margins as prices rise—that is generally what one would want to happen, from an investing standpoint. To offer a simple illustration, higher oil prices were undoubtedly a welcome development for Canadian oil companies, who our research finds have relatively higher production costs due to the unique geography of Western Canadian oil fields—and who represent a big chunk of Canadian exports.^[xvii] Ditto for higher metals prices and Canadian miners. So we think this presents a timely, simple lesson: Sometimes what is bad for GDP maths is a-ok for corporate earnings—and the actual economy.