Today’s Headlines: 2.6% Growth in 4th Quarter GDP

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Today’s Headlines: 2.6% Growth in 4th Quarter GDP
February 3, 2017
Growth Slows As Expected

According to the Bureau of Economic Analysis (BEA) report released on Friday, America’s gross domestic product (GDP) grew by 2.6% in the 4th quarter of 2014. This represents a significant but not unexpected drop from 5% GDP growth in the 3rd quarter.

Many economists had predicted 4th quarter growth of 3.1%-3.2%, expecting a reduction based on an unusually high surge in defense spending and increased production leading to larger inventories in the 3rd quarter. However, JPMorgan Chase Chief Economist Michael Feroli called it correctly back in October, dropping his 4th quarter estimate to 2.5% based on these factors.

Higher Expectations on Wall Street

Wall Street did not react positively to the announcement. The Dow dropped over 250 points and the S&P 500 dropped below 2000 to close at 1994.99 amid continued frustration about the overall pace of growth.

A Wall Street Journal article suggested the report highlights a “persistently uneven recovery,” comparing it to the 3.4% average annual growth rate of the 1990’s. This comparison seems harsh for several reasons. GDP volatility is not bad in historical context and a technology boom that is currently without parallel accelerated the 1990’s recovery.

Further, a Pew Research Center study from July 2014 shows that recoveries since the 1960’s have successive decreases in the growth rates in each recovery’s first five years. It could be that with an increasingly large economy, GDP percentage is not the best way to compare relative recoveries.

For the year, 2014’s GDP growth was 2.4% – a slight increase over 2.2% growth in 2013. Keep in mind that the 2014 GDP includes a 1st quarter contraction of 2.1%, arguably driven by a harsh winter, thus the growth rate over the last three quarters averaged slightly over 4%. Should the 4th quarter estimates be revised upward in February, the recent growth will be even more impressive.

It appears Wall Street may be overreacting to quarterly changes, rather than looking at longer-term growth — which has been relatively steady over the last four years and is likely to continue as such through 2015.

Economic Signs for 2015

What should we expect heading into 2015? Overall, signs point to the steady, if not spectacular, growth.

The BEA report noted that consumer spending grew by 4.3% in the 4th quarter, presumably fueled by low oil prices (pun intended). Meanwhile, the University of Michigan Consumer Sentiment Index reached an 11-year high of 98.1, up sharply from 93.6 in December. Unemployment has dropped to 5.6% and is likely to continue to drop in 2015. These factors should keep consumer spending relatively high in the short term and make up for the lower business investment (1.9%) and eventually spur greater manufacturing growth.

Recent earnings reports have been mixed but decent overall, as Apple overshadowed the bunch with record quarterly revenue and earnings. The Dow and S&P P/E ratios do not show massive overvaluation, and other market fundamentals are reasonably solid.

Exports increased at a lower rate in the 4th quarter (2.8%, down from 4.5% in the 3rd quarter), in part because of the strong dollar and the general worldwide economic slowdown. While this may cancel out part of the domestic consumer spending growth, the momentum of greater spending should prevail.

Meanwhile, President Obama has outlined a budget that will significantly increase government spending and do away with sequestration cuts. As constructed, the budget has no chance of getting through a Republican Congress, but any compromise is likely to include some increase in government spending – especially for infrastructure, if it can be paid for in a manner that is palatable to Republicans.

Overall, the economic positives clearly seem to outweigh the negatives. Expecting sustained growth of 5% is not realistic at the moment, but sustained 3% growth seems attainable without rising inflation and corresponding interest rates increases from the Fed.

Lower gas prices are likely to help consumer spending for some time, but wages need to rise to make that a more permanent condition and drive growth to higher rates. The current wage condition combined with a strong dollar and economic concerns in Europe and Japan are also likely to keep recovery rates below what they could be.

The Takeaway

In a way, this may be the perfect report despite Wall Street’s initial reaction. It shows a continued growth rate over time and falls in line with many economists’ expectations of 3% growth next year – enough growth to outpace inflation, but not enough to spur the Fed into early action.

With the Fed unlikely to act before June – and perhaps even later – stocks should recover from their recent funk as Wall Street grasps the fact that while 5% growth was probably a short-term illusion, we are still in decent economic shape. Last January, the S&P sank 3.6% only to be followed by a 4.3% rise in February. This year’s 3.1% January drop may see a similar surge.

Expect similar short-term volatility in GDP growth and other market metrics (like the Dow), but expect any extreme swings to cancel each other out and bring growth into the 2.5%-3% range for 2015. The outlook may be a bit brighter if the overseas stimulus efforts are successful. Stocks should rebound and the Dow should resume its likely march toward 20,000.

Do not get overly concerned by single quarter drops (like Q1 2014) or overexcited by large jumps (like Q3 2014). Stick to your long-term investment strategy. There seems to be little reason to shift away from it now.

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