Drilling Down On Energy’s GDP Impact

Is US growth faltering? Last Friday's third estimate of Q4 GDP showed the US grew just 1.4% annualized, after rising 2% in Q3 and 3.9% in Q2. The Atlanta Fed's GDPNow model-a newfangled GDP forecasting tool-has ratcheted down Q1 forecasts to 0.6% from 2.3% just a few weeks ago. Some warn the US is hitting stall speed and risks lapsing into recession, even though laws of physics have never applied to economies. Moreover, the Energy sector continues bearing most of the blame for lackluster headline data. This isn't a sign of economic weakness-that the US continues growing despite Energy's troubles shows just how diversified and resilient our economy is. That's something for stocks to cheer, not jeer.

We've broken out Energy's economic impact a few different ways in recent months, isolating its impact on business investment, industrial production and more. State-level GDP, just released for Q3 2015, provides another view. Now, we realize it probably seems odd to counter Q1 forecasts with data from the prior year's Q3, but it illustrates the point. After all, Q3's broader GDP slowdown drove fear of a faltering US economy, too, and the geographic breakdown makes it clear weakness was isolated to a handful of resource-heavy states, as shown in Exhibit 1.

Exhibit 1: State GDP Growth, Q3 2015

Source: Bureau of Economic Analysis, as of 3/31/2016. GDP growth at seasonally adjusted annual rates and mining as a percentage of GDP.

Oil-heavy Alaska and North Dakota contracted, as did coal-heavy West Virginia. This should come as no surprise, given Energy's slump over the past year and a half and coal's losing battle with natural gas. But the six weakest states are only 11.4% of US GDP. The other 44, most of which depend far less on natural resources, are more than fit to pull the country along. (Exhibit 2)

Exhibit 2: Most US States Are Growing Faster Than Country Itself

Source: Bureau of Economic Analysis, as of 3/28/2016. Q3 GDP growth at seasonally adjusted annual rates.

Investment in new mines and oil wells has plunged lately, dragging down resource-heavy states. But overall business investment has held fairly steady as other sectors continue growing. Mining is a small portion of overall business investment, and it was a small fraction before it began plunging in Q1 2015. Investment by the service sector is far greater. IT-related spending^[i], for one, was more than 10 times mining investment in Q4. Investment in commercial and health care structures more than doubled mining investment. R&D spending more than quadrupled it. Hence why GDP continues growing even as the Energy sector suffers. It's too small to drag down the entire economy (Exhibits 3 and 4). The same holds true when you look at labor markets. (Exhibit 5)

Exhibit 3: Mining Is a Small Slice of Business Investment

Source: Federal Reserve Bank of Saint Louis, as of 3/29/2016. Investment in mining exploration, shafts and wells and total non-residential fixed investment in billions of dollars, Q3 2010 - Q4 2015.

Exhibit 4: Energy Investment's Share of GDP

Source: Bureau of Economic Analysis, as of 3/29/2016. Mining exploration, shafts, and wells as a percentage of GDP, Q1 2005 - Q4 2015.

Exhibit 5: Job Growth With and Without Mining

Source: Federal Reserve Bank of Saint Louis, as of 3/29/2016. Total Nonfarm Payrolls and Total Nonfarm Payrolls Ex. Mining, January 2010 - February 2016.

It may be hard to see, but there are two distinct lines in this last chart. The reason they are so close together is because only about 682,000 thousand people work in mining, down from over 850,000 in the fall of 2014. Over the same period, total jobs rose from about 138 million to almost 143 million. Here, too, Energy's troubles are a small headwind nationally.

Given oil, gas and coal production impacts the economy to a small degree, it's unlikely to derail growth looking forward, even if the industry's woes persist. In a way, Texas demonstrates this. Home to the Eagle Ford shale field and over one-third of US oil production, Texas is the country's biggest oil producer by a mile. It pumps over twice as much oil per month as North Dakota. Yet Texan GDP grew-barely, but growth is growth-while North Dakota shrank. How'd it happen? After being hit hard by the early 1980s oil downturn, Texas diversified its economy. The state's reliance on oil and gas has fallen by half since the 1980s, while industries like technology, finance, manufacturing and cyber-security have flourished. These other industries have picked up the slack, helping Texas largely weather Energy's woes.

Exhibit 6: Texas GDP By Industry

Source: Bureau of Economic Analysis, as of 3/31/2016.

The story is much the same nationally. While resource production and investment are slumping, the US's mighty services industries are driving growth. In Q4 2015, consumer spending on services contributed 1.3 percentage points to GDP's 1.4% growth rate. According to the Bureau of Economic Analysis, as of Q3 2015, private services-producing industries account for 68.2% of total GDP on a gross value-added basis.^[ii] Overall and on average, the service sector is healthy and profitable, with plenty of cash to invest and keep growing. Even if Energy struggles for the foreseeable future, the much larger, healthier parts of America's economy should continue pulling the country through. As it does, economic reality should surprise investors' rather low expectations, propelling stocks higher.