Q4 GDP Decreases 0.1%

The expectation for fourth quarter GDP growth certainly was not high, but the 0.1% contraction was worse than expected. The full text of news release from US Commerce Department can be found here, which always comes in the most matter-of-fact intonation:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 0.1 percent in the fourth quarter of 2012 (that is, from the third quarter to the fourth quarter), according to the "advance" estimate released by the Bureau of Economic Analysis.  In the third quarter, real GDP increased 3.1 percent.

Market reaction, however, is decided muted. Even though the headline numbers look horrific, the underlying thesis of a slowly recovering economy remain unchanged. The Q4 GDP numbers were adversely effected by the 22% decrease in defense spending and the less than expected inventory accumulation due to uncertain fiscal climate during the fourth quarter. Here are the good news in the report:

Real personal consumption expenditures increased 2.2 percent in the fourth quarter, compared with an increase of 1.6 percent in the third.  Durable goods increased 13.9 percent, compared with an increase of 8.9 percent.  Nondurable goods increased 0.4 percent, compared with an increase of 1.2 percent.  Services increased 0.9 percent, compared with an increase of 0.6 percent. 

Real nonresidential fixed investment increased 8.4 percent in the fourth quarter, in contrast to a decrease of 1.8 percent in the third.  Nonresidential structures decreased 1.1 percent; it was unchanged in the third quarter.  Equipment and software increased 12.4 percent in the fourth quarter, in contrast to a decrease of 2.6 percent in the third.  Real residential fixed investment increased 15.3 percent, compared with an increase of 13.5 percent.

With personal consumption, durable goods, investments, both residential and nonresidential structures increasing at a comfortable pace, no wonder the market wasn't too worried about the misleading headline.

Consumer confidence has been gloomy over the past several months, yet consumer spending has been expanding. Looking at the consumers' balance sheets, even though deleveraging is still occurring on the surface, those numbers are now entirely due to firmer asset values instead of actual increase in savings or paying down of debts. At such low interest rate, there is strong incentive to spend, not to save. That, I believe, is the most important reason for increased level of consumption. However, with the tax increase beginning this year, consumers are now actually drawing smaller paychecks. Will such robust spending continue? That remains to be seen.