We've just 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 percent in the fourth quarter compared to the third quarter. The reported growth rate was much weaker than the consensus expectation for 1.1 percent 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?
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A closer look at the details will show that the headline figure of -0.1 percent is not indicative of the true underlying pace of economic growth.
Most importantly, a 6.6 percent decrease in government spending in the quarter subtracted 1.33 percent from the overall Gross Domestic Product growth figure. This decline in government spending was due to a 22 percent 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 percent 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 percent from the reported 4Q growth rate.
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Adjusting for these two items, GDP would have grown 2.5 percent in the quarter - a deceleration from the 3Q rate of 3.1 percent but faster than the average of 2.1 percent since the end of the Great Recession.
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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 percent 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 percent in the quarter driven by 12.4 percent growth in Equipment & Software and 15.3 percent 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, the 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 the recent GDP report to discourage the notion of slow and steady progress on the economic front.
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Michael K. Farr is President and majority owner of Farr, Miller & Washington, LLC. He is Chairman of the Investment Committee and is responsible for overseeing the day to day activities of the firm. Prior to starting FM&W, he was a Principal with Alex Brown & Sons.
Mr. Farr is a paid Contributor for CNBC television and has appeared on numerous broadcasts and has been quoted in global publications. He is a member of the Economic Club of Washington, DC, National Association for Business Economics, The World Presidents' Organization, and The Washington Association of Money Managers. He is the author of "A Million Is Not Enough," and "The Arrogance Cycle."