Dissecting Germany’s GDP

When is a growing economy bad news? Apparently, when it’s the “wrong kind” of growth. Take German Q4 GDP, which hit Tuesday. The headline growth rate of +0.4% q/q should have been overall welcome news—Europe’s biggest economy is still advancing, if not at a robust pace—but because exports drove the increase, headlines are skeptical of Germany’s viability and even calling it a drag on the eurozone. In our view, that’s a rather short-sighted take. Yes, Germany’s GDP breakdown shows a bit of domestic weakness, but one quarter doth not a trend make—unevenness is normal during recoveries. But the popular take is telling as a sign of the times—it shows headlines are still on the hunt for bad news, providing one more piece of evidence this bull market has plenty of wall of worry to climb.

The numbers are largely as reported—exports grew +2.6% q/q and contributed 1.4 percentage points to total GDP growth.¹ This isn’t the first time exports have largely propped up growth—exports’ contribution has exceeded headline growth multiple times in recent years. But this doesn’t imply domestic demand is weak (more in a bit). Nor does it mean Germany is sucking demand from its neighbors, flooding them with German goods when it should be importing goods from other eurozone countries to give them a lift. If that were the case, we likely wouldn’t have seen the eurozone recovery broaden in Q4, with Spain, Italy, Portugal, France and other eurozone nations showing growth in internal and external demand. Simply, higher German exports help neighbors! Products are rarely produced start to finish in one country—many German manufacturers import raw materials and intermediate components from other eurozone countries—the more finished goods Germany exports, the more it needs to import from neighbors. German imports, as it happens, rose +0.6% q/q.

While rising imports do show domestic demand is better than perceived, it’s not hard to see why other components of German GDP would give the opposite impression. Household spending, which represents about 57% of German GDP, fell -0.1% q/q. However, that figure was still up +0.9% over Q4 2012.² Sure, it’s possible the small Q4 drop could be an inflection point—anything is possible—but it could also just be another instance of the data variability that normally occurs during recoveries. German household spending had one-off declines in Q1 2012 and Q2 2011, but the longer-term trajectory stayed positive.³

Most headlines, however, focused on investment (Gross Capital Formation, or GCF), which took an even greater hit at -3.8% q/q. But this figure isn’t terribly telling. On the whole, GCF detracted 0.6 percentage point from headline growth. But a decline in inventories, a subset of GCF, detracted 0.8 percentage point. The difference, fixed investment, grew and contributed 0.2 percentage point to total growth. Not big, but still a modest increase in demand.

As for inventories, the decline isn’t inherently negative—it could be good or bad, depending on the circumstances. For example, if the decline meant businesses were getting lean in anticipation of falling demand, which typically happens during recessions, it wouldn’t be good news. However, there isn’t much evidence that’s the case today, with service and manufacturing new orders rising again in February at the swiftest pace in three months. This strongly suggests the decline in inventories was more likely the normal drawdown that happens when businesses underestimate demand, which perhaps implies an inventory (and production!) boost down the line as businesses restock.

Overall though, the GDP report is largely confirmation of what investors already knew: Germany, like the broader eurozone, is growing at a modest, uneven rate, with pockets of strength and weakness within its economy. As long as headlines focus overly on the weaker areas, as they are today, that tells us expectations are still broadly too low—plenty of skepticism remains in the global economy, and looking forward, it won’t take much improvement for stocks to get a positive surprise.