Last week we received news that Gross Domestic Product contracted at an annualized rate of 1.0% in the first quarter of 2014. The original guestimate from the Bureau of Economic Analysis (BEA) was +0.1%. It’s not uncommon for the BEA to revise its initial estimates, but this sharp revision into negative territory deserves some explanation.
In a nutshell, the weakness in the 1Q was attributed to poor weather, slower inventory growth, and a sharp decrease in net exports. The decrease in inventory growth caused a 1.62% drag on overall GDP growth in the quarter, while the effects of weather could be seen throughout several other categories within Gross Private Investment. In the aggregate, Gross Private Investment fell at an 11.7% annualized rate in the quarter. This drag was more than enough to offset growth in Personal Consumption, which accounts for about 70% of GDP, of +3.1% in the quarter. It should be noted, however, that the growth in Personal Consumption was aided by high levels of utilities spending, which was also a result of the cold winter weather. Consumer spending on goods (as opposed to services, like utilities) contributed much less to GDP growth than in the previous several quarters. And finally, net exports subtracted 0.95% from overall GDP growth in the quarter as exports fell at a 6.0% annualized pace.
We have little doubt that economic growth will return to positive territory in the second quarter. According to a Bloomberg survey of economists, second quarter GDP growth will come in at +3.5%. This level of 2Q growth, if achieved, would still put first-half growth at roughly the same anemic pace we have experienced since the end of the recession. In my opinion, economists should be somewhat more concerned than they are that the economy is still unable to withstand minor, transitory setbacks such as poor weather without dipping into contractionary territory. To us, this means that the economy remains on shaky foundation. Instead of consistently strong, positive economic growth each quarter, we keep hearing excuses about temporary drags on growth and why growth is likely to accelerate “next quarter.” It reminds me of the movie Animal House, in which the character Hoover (Delta house President) tells Dean Wormer that “We’re hoping that our mid-term grades will really help our average!”
We received further evidence this morning that the economy is not ready to break out of its low-growth malaise. According to ADP, private payrolls increased just 179,000 in the month of May – well shy of the consensus estimate and down from the April figure of 220,000. The report throws a bit of cold water on the thesis that inclement weather caused subdued hiring activity over the winter. While the unemployment rate has drifted much lower over the past several years, the quality of new jobs remains weak, and inflation-adjusted income growth remains fairly non-existent. The middle class is simply not benefiting much from this recovery, and it remains hard to paint any other picture than our economy remains stuck in low gear.
Importantly, the economy’s failure to break out as many had hoped will likely result in a Federal Reserve that remains fully engaged in supporting asset prices. As long as the Fed is married to its strategy of boosting asset prices as a way to prime the economic pump, we are at a loss as to what may cause a significant correction in stock prices. It should be remembered, though, that these types of corrections sometimes occur when people (including us) least expect them. Keep your seatbelts tightly fastened!