Gross misconduct – Why market-watchers should stop obsessing about initial estimates of GDP


Ian Kelly

Ian Kelly

Fund Manager, Equity Value

These days, few things seem able to excite investors and other market-watchers like a new set of GDP figures. To be fair, the idea the initial estimate of how the last quarter’s gross domestic product – the total value of a country’s goods and services – compares with previous readings might indicate the shape of its economy seems sound enough … right up to the moment the facts get in the way. 

Here on The Value Perspective, we might feel inclined to pay more attention to GDP estimates – or, as we prefer to call them, ‘guesses’ – if the first attempts by those who provide them (or, for that matter, the second or the third) bore any resemblance, on any consistent kind of basis, to the final number that goes into the history books. The thing is, they very rarely do. 

To illustrate that point, we have put together two charts using data provided by the Federal Reserve Bank of Philadelphia. Analysts there worked through every quarterly US GDP estimate and subsequent revision published since 1964 to build a handy table showing the first guess for each three-month period, alongside the second and third guesses and the number that ultimately went down in history. 

Our first chart simply shows, in percentage-point terms, how much daylight there has been between the initial and final figures for each quarter over the last 50 years. As you can see, the only kind of consistency on show is that the final number is rarely anywhere near the initial estimate and indeed, over the period under review, the average difference has been 2.9 percentage points.


Source: Federal Reserve Bank of Philadelphia, 2015

Aside from giving investors pause for thought before they become too excited over the next GDP figure they see published, we would argue this chart also says something about economic forecasting. After all, how can anyone reasonably set about predicting what GDP will be in one year’s time when they cannot even know for sure what it was one year back? 

As an example, let’s focus in on the first quarter of 2014, when the first official stab had the US economy growing – if only by a lacklustre 0.1%, compared with the first three months of 2013. That was subsequently revised down to a 0.99% contraction and then further out to a 2.9% contraction – in the process provoking some pretty dark mutterings in the media. 

In the end, however, the powers that be settled on a final GDP growth figure for the first three months of 2014 of 0.92%. In other words, the initial estimate was wrong in both size and direction and, while the second and third estimates were right in direction, they were too pessimistic – the latter by a factor of some 200%. 

Our second chart looks at the same information in a different way – this time showing the difference in the initial and final GDP estimates as a percentage of the initial estimate, with a few of the wilder misses truncated for the sake of space. Though it may not look like it at first glance, the chart is, among other things, an interesting illustration of the difference between being accurate and being precise.


Source: Federal Reserve Bank of Philadelphia, 2015

What we mean by that is, on average, the final GDP readings are not so very far off – working out as some 20% higher overall. The problem is, the standard deviation on all the data is 277%. In darts terms, that is like claiming your average throw is an inch or two from the bull when half your darts have landed three feet to the right of the board and the other half have landed three feet to the left. 

Regardless of actual facts, of course, the thrill of the new means investors and other market-watchers will continue to obsess over initial GDP estimates while barely paying a second glance to the readings that go down in history. Whether that means you might actually do better to buy the market when GDP has proved overly disappointing, however, would require a whole new round of data-crunching …


Ian Kelly

Ian Kelly

Fund Manager, Equity Value

I joined Schroders European equity research team in 2007 as an analyst specialising in automobiles. After two years I added the insurance sector to my coverage. In early 2010 I moved into a fund management role, and then took over management of two offshore funds investing in European and Global companies seeking to offer income and capital growth. 

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