Frosty GDP

“The US economy slammed on the brakes,” and “nearly stalled” in the first quarter of the year. The consensus: Q1 2014 GDP was less than stellar. Growth slowed to a +0.1% seasonally adjusted annual rate—missing expectations for +1.2% and a significant drop from Q4 2013’s +2.6%. Most observers blamed cold weather and expect growth to rebound quickly—a sign of where sentiment is today, and in our view, a fairly accurate interpretation. There should be plenty of growth left to support this bull market.

A close look at the underlying components suggests weather was indeed a major culprit. As you’d expect during a season that featured blizzards in Oregon and Georgia and a near-national cold-front so severe it was dubbed the Polar Vortex, household spending on services jumped +4.4% as folks hunkered down with the heater on maximum. And it probably goes without saying that far fewer folks trudged through the snow and rain to find that perfect new home, leading to residential real estate investment’s -5.7% fall. Meanwhile, businesses were hit by weather-related closures and power outages, contributing to a -2.1% drop in investment. And because production went offline, they drew down inventories to meet demand, shaving 0.57 percentage point off headline growth—which probably means Q2 growth will get a boost from restocking.

In a refreshing twist, folks largely met the news with a yawn. Most were expecting a winter slowdown, though perhaps not to this extent, and they’re already looking to better days ahead. This isn’t 2012 or 2011, when folks would cling to any negative data point as a sign of weakness ahead. Now they’re looking at across-the-board accelerations in March data as evidence the spring thaw has already started—a fairly rational, optimistic take. In our view, that’s yet more evidence of where we are in this market cycle. Sir John Templeton famously said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” Optimism is taking hold, but expectations for a brighter future aren’t irrational—we’re still far from euphoria typical of bull market peaks—proof, in our view, more bull lies ahead.

The thesis that Q1’s slowdown should just be a blip seems spot on. The Leading Economic Index (LEI) is still rising and even accelerated in March, jumping +0.8%—not consistent with a weakening economy. The steeper yield curve has started working its mojo, with business lending accelerating markedly. The Institute of Supply Management’s (ISM) April manufacturing Purchasing Managers Index rose to 54.9—up from March’s 53.7—heading further into expansion. The forward-looking new orders subcomponent remained solidly expansionary at 55.1, suggesting demand isn’t waning. Personal spending accelerated in March to +0.9% m/m—the largest monthly gain since August 2009—led by a 1.4% gain in spending on goods (a change from the utilities-driven gains in winter). Personal incomes also continued their rise (+0.5%), which should support consumption looking ahead.

Even the Fed noted the recent improvement, shrugging off the GDP read and raising their assessment of the economy’s health in the policy statement released Wednesday. Out was the March language saying activity had slowed—the data gathered since indicate things have “picked up.” That was good enough for another reduction in monthly bond purchases—quantitative easing—which will drop by another $10 billion to $45 billion next month. If even our backward-looking, demand-obsessed central bank isn’t overreacting to a big GDP slowdown, that’s a sign sentiment is far removed from those panicky days of 2012 (and 2011, 2010, 2009 ... )

Overall, even with Q1’s US slowdown, the preponderance of evidence suggests the economic fundamentals underpinning this bull market are alive and well. The US isn’t grinding to a halt, and much of the rest of the world grew just fine in Q1. UK Q1 GDP grew 0.8% q/q (3.1% annualized)—its fifth straight strong read. South Korea grew +0.9% q/q (3.9% y/y), its fastest growth in three years. China grew a robust +7.4%—slower than the world is used to, but still high. With growth continuing and investors gaining confidence, this bull market should have plenty of support looking ahead.

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