/perspectives/global-cio-outlook/the-good-news-behind-gdp-s-decline

The Good News Behind GDP's Decline

As the U.S. economy maintains its momentum and with the euro zone showing signs of improvement, all eyes are now on the Fed’s next move on rates.

February 05, 2015    |    By Scott Minerd

Global CIO Commentary by Scott Minerd

On Friday, it was announced that U.S. gross domestic product rose an annualized 2.6 percent in the fourth quarter—a marked slowdown from the 5 percent growth we witnessed in the third quarter of 2014. But what the market took to be bad news was actually a sign of economic strength.

Falling net exports subtracted a full percentage point from GDP growth. But net exports—exports minus imports—only looked relatively weak because consumer demand for imports was so strong, growing at an annualized rate of 8.9 percent quarter over quarter. In fact, this past December, U.S. companies imported $48.8 billion worth of consumer goods, an all-time record figure.

In the fourth quarter, household consumption was the main driver of GDP growth, up by over 4 percent. This is a positive sign for the U.S. economy, particularly when considering that nearly 70 percent of economic activity in the United States stems from private consumption.

Durable goods orders, which fell by 3.4 percent in December, also rattled investors when the number was released last week. Durable goods orders is the one data set I actively ignore—it is one of the most volatile economic indicators and is often revised significantly from one month to the next. Taken in isolation, a one-month drop in durable goods orders does nothing to support the thesis of a weaker economy. Fluctuation just means some big order came through or some big order didn’t come through, and it should not move markets. That investors latched onto the weak durable good numbers is, I believe, as misguided as their take on the GDP print. Economic fundamentals in the United States remain sound.

The economic environment in Europe is also showing signs of improvement, and I expect this trend to continue throughout the year. Loan growth is picking up, quantitative easing starts in March, and while the latest Greek tragedy plays out in Athens, I expect European policymakers will be diligent in not allowing Greece to write off any of its debt for fear such an occurrence may inspire others, such as Spain or Portugal, to demand the same.

As the global economy gains strength and U.S. economic data continues to improve, investors are now likely to focus on the Federal Reserve’s next move. In an interview with Bloomberg last week, James Bullard, president of the St. Louis Fed, expressed his view that investors are wrong to expect the Federal Reserve to postpone an interest-rate increase beyond midyear, citing the decline in unemployment levels and the underlying momentum in the U.S. economy.

Bullard is a policymaker I hold in high regard and, judging by his comments, market chatter of interest rates hikes being postponed into 2016 now appears overdone. In all likelihood, given policymakers’ concern that the economy will overheat if they leave rates too low for too long, I think that a rise in rates somewhere between September and December is a fair estimate.

Import Growth Is a Good Sign for the U.S. Economy

Though fourth-quarter GDP came in below expectations at 2.6 percent, much of the apparent weakness was due to falling net exports, which subtracted a full percentage point from the growth figure. But net exports fell because imports grew at a faster rate, a sign of strong domestic demand. In other words, the same factors that are leading to a healthy growth rate in consumption, such as an improving labor market and increased consumer confidence, are also causing higher demand for imports. The bottom line is that the U.S. economy is doing very well and looks set to continue this momentum.

Imports Typically Rise as Personal Consumption Increases

Import Growth Is a Good Sign for the U.S. Economy

Source: Haver, Guggenheim Investments. Data as of 4Q2014.

Economic Data Releases

U.S. Activity Mixed as Inflation Heads Lower

  • The ISM manufacturing index was worse than expected in January, decreasing to a one-year low of 53.5. All of the sub-indices were lower, with a large drop in new orders.
  • The ISM non-manufacturing index ticked up in January, rising to 56.7. New orders were up while the employment index fell.
  • Factory orders were worse than forecast in December, dropping 3.4 percent after a revised 1.7 percent fall in November.
  • Personal income rose 0.3 percent in December, while personal spending fell 0.3 percent, the largest monthly decline since 2009.
  • Initial jobless claims rose by 11,000 in the last week of January, up to 278,000.
  • The trade gap unexpectedly widened in December, with the deficit increasing to the largest level in over two years, at -$46.6 billion.
  • The core Personal Consumer Expenditures deflator, the Fed’s preferred inflation measure, continued to decline in December, falling to 1.3 percent year over year, a nine-month low.

Euro Zone Data Continues Slow Improvement

  • The euro zone manufacturing Purchasing Managers Index was unchanged in the final January estimate at 51.0. Germany’s PMI fell in January, while France, Spain, and Italy showed improvement.
  • The euro zone services PMI was revised higher in January, reaching a five-month high of 52.7. January saw improvements in Germany, Spain, and Italy, while France fell into contraction.
  • Euro zone retail sales expanded for a third straight month in January, rising 0.3 percent, beating expectations.
  • German factory orders rose 4.2 percent in December, the best month since July.
  • The manufacturing PMI in the U.K. rose slightly in January, up to 53.0 from 52.7.
  • The U.K. services PMI rebounded in January, rising from 55.8 to 57.2.
  • China’s official manufacturing PMI slipped into contraction in January at 49.8, the lowest since September 2012. The non-manufacturing PMI also declined.
  • China’s HSBC services PMI declined to a six-month low of 51.8 in January.

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