Still Growing

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Today's GDP report is difficult to interpret. On the one hand, growth was weaker than economists' expectations. On the other, it was still growth, meaning the continually touted US recession will have to wait at least another quarter (if it comes at all).

Economy Much Weaker Than Expected
By Chris Isidore, CNNMoney.com senior writer
https://money.cnn.com/2008/01/30/news/economy/gdp/index.htm?postversion=2008013010

Unpacking GDP figures and understanding them in the proper context is no easy feat. Particularly on a quarterly basis, GDP growth is highly erratic. It's not as smooth a ride as many imagine. 2007 is a prime example. On an inflation adjusted basis, Q1 2007 growth was surprisingly weak—well below 1%. Yet, the second and third quarters surged ahead. Q3 growth hit 4.9%. Now to finish the year we're back in that less than 1% territory. That means a single quarter of GDP doesn't tell us much about the full year or even the period immediately ahead. On balance, 2007 US GDP growth will probably end up around the 2.2% range.

Once again, just about all the major categories of GDP grew for the year. The equation is as follows:

GDP = Consumption + Investment + Government Spending + (Exports – Imports).

Most all major categories experienced solid growth in 2007. Consumption—the largest component of GDP—moved along fine. Major weakness came from the investment sector, where residential construction contracted. But even at that, non-residential construction (a proportionately much larger component relative to residential) grew nicely and offset a good chunk of the decline. And government spending grew at a healthy clip (no surprise there).

One of the unsung heroes of GDP this year was exports, which chugged ahead. It's an interesting quirk of GDP accounting that imports are counted against growth. While of course it's not appropriate to count imports as part of the domestic product, in our view it's strange to actually subtract it. High levels of trade activity on both sides of the ledger are probably best viewed as an economic good and not an offset to each other.

In sum, it was a perfectly fine year for growth—some areas waned while others surged.

Many think of the economy as a proxy for the stock market. In truth, (and particularly on a short-term basis), economic growth isn't necessarily predictive of stock returns. It's true that, as the economy tends to grow, so do stocks—but magnitude and timing vary widely. Think back again to 2007 as an example. In the first quarter, US GDP growth was relatively weak but stocks performed quite well. The second and third quarters of ‘07 saw excellent real GDP growth, but in those same periods we saw corrections and even negative stock returns in the periods during and immediately following—even though the economy kept growing nicely.

One reason is that stock markets and GDP are simply not the same thing. GDP is a statistical calculation inclusive of metrics like net exports, government spending, and other items stock markets are not explicitly concerned with. Stock markets are explicitly concerned with, well, stocks and the performance of companies they represent—not the aggregate economy, which covers much broader territory.

In general, advance GDP numbers are subject to significant revisions (could be up or down), and the revisions are often big. In the third quarter last year, the size of the revision was significantly more than the 0.6% number reported today. Additionally, anecdotal evidence suggests the second half of the quarter may have been significantly stronger than the first half, yet a lot of the calculations for the advance report are based off the first half of the quarter. So this preliminary number doesn't tell us all that much and could be a head fake in either direction.

Lastly, recall that the US is only 25% of the global economy (including emerging markets). The non-US economy is three times bigger. However, the global economy and the US are vastly intertwined, making it highly unlikely one will zig while the other zags. The world economy is expected to grow nicely again in 2008 to the tune of 4.1% (according to the IMF). It's far more likely in our view the gravitational pull of the larger 75% will keep the 25% (the US) moving along.

We'd strongly caution against putting too much emphasis on today's GDP report. On balance, it appears the US economy continued growing, and fundamentals for stocks remain favorable in the period ahead.