US Q3 GDP Revision: All About Inventories

Tuesday, US Q3 GDP was revised down from an initial reading of 2.5% q/q annualized to 2.0%. While 2% is slower than the initial report, it still represents acceleration from Q2’s 1.3% annualized rate. This may be the first revision of Q3 GDP, but it won’t be the last. GDP is always revised later as more data come in, often substantially. Folks will quibble about the magnitude, but the bottom line is it shows the recent growth trend continues—a far cry from the recession many feared just a few months ago.

It’s also worth remembering one should never put too much stock in a single quarter’s GDP reading given economic data’s inherent volatility—a fact early 2011’s deceleration illustrates pretty well, now that US GDP has sequentially accelerated the past two quarters. If one pulled the plug and ran every time GDP decelerated toward zero, they’d be fitter than an Olympic sprinter.

What’s more, for stocks, the second guess is usually less meaningful than the first. Fact is, the more time elapses between the quarter being reported on and the present, the less it matters to inherently forward-looking stocks. But there are nuggets of useful data one can glean, even from revisions that come long after the quarter’s said and done.

Some might look at a downward revision to headline data and presume this means the US economic outlook is more glum than it was yesterday. But this is where headline data can easily lead an interpreter astray. Digging into revised Q3 data, the outlook arguably appears better than in the initial report, not worse.

Why? The downward revision was due to a larger-than-expected decrease in inventories. Non-residential construction also decreased slightly, but was made up for by stronger net exports, leaving inventories as the swing factor. This is likely indicative of firms’ hesitancy to stock their shelves amid all of the recent volatility—exercising caution regarding costs.

But in the near future, those bare shelves seem on a collision course with holiday shopping season. Ultimately, stores need goods to stock on shelves for when merry ol’ shoppers come along looking for gifts and trinkets. That increased demand, combined with an already growing economy and dwindling inventories, creates the potential for acceleration in the quarters ahead as inventories are eventually re-stocked. After all, there is a limit to how far one can de-stock inventories.

Once those inventories are depleted, stores typically don’t close their doors and say, “We’re spent.” They’ll generally reorder—and in this day and age of fast-moving technology and inventory management, that could easily create an uptick in output at factories and the like. Given the currently low inventory-to-sales ratio, it wouldn’t take much for that to happen today. All that reordered stuff must be shipped. Has to be loaded and unloaded. Has to be sold by workers at stores or catalogued, shipped and managed by workers at internet retailers. In that way, low inventories at this point in the cycle can be indicative of better conditions ahead.

Don’t be fooled by a downward revision to a headline statistic occurring nearly two months after the quarter ended. The real, more impactful stuff for investors is under the surface.