- US GDP outperforming expectations in the fourth quarter is good news, but you wouldn't know it from the headlines.
- Primarily due to business inventories—many worry the growth is unsustainable. But all cylinders don't have to fire simultaneously, and often won't early on.
- Comparing GDP's general trend to its public reception confirms that though the world is much better than folks would have thought a year ago, worry still abounds.
- Bull markets feed on this gap between sentiment and reality.
US GDP grew at its fastest pace in six years in the fourth quarter (+5.7%), outstripping economist expectations by almost 1%, and mitigating 2009's 2.4% decline overall. This. Is. Good. News. But you wouldn't know it by muted headlines and a heavy bout of "buts."
The lion's share of the growth was driven by business inventories (+3.4%)—not outright inventory growth, but dramatically decelerating inventory liquidation. Consumption and net exports added +1.4% and +0.5% respectively. Yet the pessimism of disbelief was quick on the draw to qualify: Yes, this seems good—but…inventory-led growth isn't sustainable.
It's true such sharp changes in inventory won't last forever. But that's no reason to believe last quarter's blockbuster GDP isn't a great sign. Few would have believed in an almost 6% growth rate just a year ago. And economic recovery is a bit like the game Mouse Trap: One segment leads, then nudges the next leading segment—on down the line. All cylinders don't have to fire simultaneously, and often won't early on.
Dramatically slowing inventory liquidation shows bullish private sector sentiment. Ultra-fit firms are once again profitable and preparing for better days ahead. The next step after slowing inventory liquidation is inventory growth, new orders, rising manufacturing, etc. That in turn means higher business spending—which as we've said before led the downturn and should lead the recovery. (What falls most, bounces most.) From there, firms will finally start hiring again.
And speaking of hiring, what about that perma-fret, consumer spending? It's widely thought the economy can't recover until consumption recovers, which in turn must wait on job growth. Considering the labor market is usually the last thing to turn—that could be quite a wait. But don't worry. Though consumption is the biggest part of national production, it's not as variable as you think—contributing less to a falling and rising economy than widely believed. And despite stubbornly high unemployment, Q4's +2% consumer spending (contributing +1.4% to overall growth) wasn't too bad at all.
The argument that today's growth is artificially propped by federal spending was notably missing from doubtful ruminations this quarter. Why? GDP accelerated in the fourth quarter despite shrinking government spending q/q. Not to mention the expired cash-for-clunkers program—often credited with Q3's positive GDP. But remember, the fiscal stimulus is still only partially spent. Government spending is likely to add to GDP in coming quarters. (Whatever rhetoric you hear about budget freezes on Capitol Hill—we'll believe it when we see it.)
Of course, GDP is backward-looking and promises nothing about future growth. Not to mention it's inherently wonky and often revised. But GDP is supposed to be an indicator, not a natural law. Comparing GDP's general trend to its public reception confirms that although the world is much better than folks would have thought a year ago, worry still abounds. Bull markets feed on this gap between sentiment and reality.
The debate may have you sitting on your hands, full of doubts. But nothing is sustainable—until it is. And for investors, by then it's often too late.