This morning we received preliminary data about the pace of economic growth in the fourth quarter of 2012. The Commerce Department says that the economy shrank by 0.1% in the fourth quarter compared to the third quarter. The reported growth rate was much weaker than the consensus expectation for +1.1% growth and is also the lowest quarterly growth rate since the end of the “Great Recession” in June, 2009. So what is going on here? Are we on the cusp of another recession, or were today’s figures simply an aberration?
A closer look at the details will show that today’s headline figure of -0.1% is not indicative of the true underlying pace of economic growth. Most importantly, a 6.6% decrease in government spending in the quarter subtracted 1.33% from the overall GDP growth figure. This decline in government spending was due to a 22% drop in defense spending in the quarter – the biggest such decrease in defense spending in several decades. The second big factor affecting overall growth in the 4Q was a decrease in the rate of inventory growth, which subtracted another 1.27% from the overall growth rate. Inventory growth was negatively (and temporarily) affected by poor weather, including Superstorm Sandy and the summer droughts in the Midwest. Together, the decrease in defense spending and the decrease in inventory growth subtracted 2.6% from the reported 4Q growth rate. Adjusting for these two items, GDP would have grown 2.5% in the quarter – a deceleration from the 3Q rate of +3.1% but faster than the average of +2.1% since the end of the Great Recession.
Meanwhile, the components of GDP that are critical in gauging the true strength of the economy were reasonably strong in the quarter. Most importantly, the largest component of GDP, Personal Consumption, grew 2.2% in the quarter. This pace of growth represents an acceleration from the second and third quarters of the year and should be greeted positively given the fears about the fiscal cliff and tax hikes. Secondly, Fixed Investment rose 9.7% in the quarter driven by 12.4% growth in Equipment & Software and 15.3% growth in Residential Construction. Again, these results are strong in the face of such fiscal uncertainty.
Below we show the contribution to GDP growth in the quarter by each of the major components of GDP. The drag from lower inventories is reflected within Gross Private Investment, more than offsetting the strength in Equipment & Software and Residential Construction.
Contribution to Change in 4Q GDP
Personal Consumption 1.52%
Gross Private Investment -0.08%
Net Exports -0.25%
Government Consumption -1.33%
Total Change in GDP -0.14%
In summary, today’s headline GDP figure should neither be cause for alarm nor cause for celebration. The economy appears to be growing pretty much in line with expectations but not enough to meaningfully reduce unemployment. Therefore, we would expect the Fed to remain fully engaged. For stock investors, the Fed’s aggressive monetary easing has led to strong gains for the past few years as investors have sought higher returns on their investments. While we are uncertain how long the rotation back into stocks will continue, we see nothing in today’s GDP report to discourage the notion of slow and steady progress on the economic front.