What the hell happened to the economy?

Expansions are just not supposed to contract. It makes people wonder about whether to hire or take vacations or buy cars. Not good. So this morning's headline number on fourth-quarter gross domestic product - a surprising 0.1 percent drop in the annual rate of growth - is bound to raise a few questions. Yet when you drill down on the internals behind the decline - the first quarterly drop in about four years - the takeaway isn't nearly as bad as it looks. Most importantly, consumer spending, which makes up the bulk of the U.S. economy, increased at a rate of 2.2 percent. A solid number. Also, residential spending was up 15.3 percent and business investment 8.4 percent. These are not numbers that would suggest a prolonged downturn. Matter of fact, it's not clear that the fourth quarter was down at all. The GDP will be revised several times, and there's a chance that the final reading will turn positive. Upward revisions are common, which is why this morning's report should be viewed with concern but not dread. From Real Time Economics:

The biggest driver was a slowdown in the rate at which businesses restocked their inventories, which on its own shaved 1.27 percentage points off fourth-quarter growth. Lower inventory growth counts as a negative to GDP, but it can often translate into faster growth the next quarter as businesses restock depleted shelves. Falling government spending and lower exports were the other big negatives, but indicators of private-sector domestic activity were much stronger. The research firm Capital Economics calls the report, "the best-looking contraction in U.S. GDP you'll ever see."

One worrisome sign is the government sector, which posted its 10th consecutive quarterly decline. That included a 22.2 percent drop in defense spending. It's a reminder that huge cuts in federal spending have nasty consequences - a point that Democrats are sure to remind everyone as the budget talks heat up in Washington. All that said, the Dow is only down about 15 points this morning. Maybe investors are just trying to look ahead.

*B of A's Michelle Meyer says today's number was "grossly distorted." Via Business Insider:

GDP contracted 0.1% in Q4, significantly below expectations. However, we advise fading the headline number given distortions in the data. Growth was dragged down by a sharp contraction in government defense spending and inventory accumulation, which combined subtracted 2.6pp from growth. Outside of these two very volatile components, underlying growth improved with a solid gain in business investment. We believe today's report suggests upside risk to our forecast of 1.0% for Q1 GDP.

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Mark Lacter
Mark Lacter created the LA Biz Observed blog in 2006. He posted until the day before his death on Nov. 13, 2013.
Mark Lacter, business writer and editor was 59
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