America’s Economy Grew in Q4

US GDP rose an inflation-adjusted 2.9% annualized in Q4, decelerating slightly from Q3’s 3.2% but topping analysts’ expectations for 2.3%.^[i] Obviously, this is another data point that doesn’t support the notion that recession started in Q4. But, under the hood, the data here extend the trend of mixed figures that prevailed for much of last year—allowing people to see whatever they want in the results. Beware the potential tendency to extrapolate backward-looking figures.

Start with GDP’s big private sector components: consumer spending and business investment. Personal consumption expenditures (PCE), 71% of GDP, rose 2.1% annualized, contributing about half of headline growth.^[ii] This slowed from 2.3% the previous quarter, which some see as suggesting trouble lies ahead. Perhaps. But with inflation slowing, we would be careful about drawing such conclusions. Trend-wise, PCE growth was led by broad-based services spending—the lion’s share of PCE—with all categories seeing gains last quarter. But most goods categories also contributed, including motor vehicles and food away from home, which were notable detractors in prior quarters.

Business investment rose 0.7%, but it was more mixed below the surface.^[iii] Intellectual property development (think software, research, media and entertainment) rose 5.3% annualized, continuing a long string of gains. Structures (commercial and industrial building) also saw slight 0.4% annualized growth after six straight quarterly declines. But equipment—mainly in information processing—fell -3.7% annualized. We would note, though, this series has been quite volatile over the last year and a half amid supply chain disruptions. However, transportation equipment has now grown three quarters in a row, suggesting bottlenecks are easing for that equipment category.

So overall, putting consumer spending and business spending together, while not great, it seems the economy’s two main engines are powering ahead. But analysts allege cracks are forming, which they see in residential investment, inventory changes and net exports.

Residential investment (think new home sales) fell -26.7% annualized—its seventh consecutive quarterly decline—and follows Q3’s -27.1% drop.^[iv] This lopped off -1.29 percentage points from headline growth—and garnered heaps of attention, raising alarms. Yet GDP grew. Because housing is only a tiny part of GDP, it is less a swing factor than many think. Then, too, what sway it does have looks set to shrink. Buyers balked from mortgage rates’ big jump earlier last year amid still-high prices. But as we look forward, we have now seen a string of big drops in residential real estate and no recession. In our view, it isn’t all that likely such huge detractions persist into the New Year, especially since rates have eased of late.

Meanwhile, trade’s 0.56 percentage point contribution is less positive than it appears.^[v] Because exports fell -1.3% annualized, while imports fell -4.6%, net exports—exports minus imports—gained. This could be a sign demand is weakening, a valid point, in our view. But here again, we would caution about extrapolating this. Trade is always a volatile category and was all over the place in 2022.

Q4’s inventory build, which added 1.46 percentage points to headline growth, is also open to interpretation.^[vi] Pundits say its growth hides underlying weakness. If this represents unwanted inventory accumulation, it could be bad—possibly a sign of excess to be wrung out later. But we wouldn’t jump to this conclusion yet. Q2 and Q3 saw big back-to-back inventory drawdowns, subtracting -1.91 and -1.19 percentage points from their respective GDP growth figures. Inventories may be rebuilding as global supply chains have been restored—amid ongoing consumer demand. Note as well: Those inventory drawdowns were key to Q2’s contraction. Few analysts then called that illusory—and you can’t have it both ways.

The upshot to all this: While GDP’s expansion continues, its components are rather mixed, which is worth being aware of—and disentangling. A fuller and more detailed picture of the economy’s moving parts lets investors separate reality from the sentiment surrounding it for a better understanding of what markets are contending with. As Exhibit 1 shows, the GDP categories that are more purely about the private sector—PCE, business investment and residential investment—slowed to 0.2% in Q4. In other words, more of the same mixed data from 2022—and likely what stocks pre-priced last year.

Exhibit 1: Private Sector Demand Growth Slow, but Positive

Source: BEA, as of 1/26/2023. Final sales to private domestic purchasers, Q1 2021 – Q4 2022.