Q4 GDP Delivers A Big Downside Surprise

The US economy unexpectedly contracted in the fourth quarter of 2012, the government reports. That's a big surprise for many analysts, including yours truly. The 0.1% decline in GDP in the final three months of last year is the first negative quarterly comparison since the Great Recession ended in mid-2009.

"You got a combination of inventories and defense which are taking more than 2 percentage points off the growth rate," Nigel Gault, chief U.S. economist at IHS Global Insight, tells Reuters. "This is not an indicator of recession."

Colleague Paul Edelstein agrees. “This really was a story about a payback in national defense spending," he explains via Bloomberg. "Consumer spending growth picked up, fixed investment was fairly strong.”

Indeed, a quick look at the GDP report reminds us that this is far from an across-the-board wash-out. Personal consumption expenditures in Q4 rose 2.2%, up from 1.6% in Q3, for instance. And while gross private domestic investment retreated 0.6% in the final three months of 2012, the nonresidential and residential components posted robust increases—the best quarterly comparisons, in fact, since 2012's Q1.

The hefty retreat in exports and government spending, combined with a reversal in inventories, tipped the scales overall to the dark side, with defense spending taking an unusually steep dive—the most, in fact, in 40 years. Yet slow growth appears to remain intact in the private sector generally, as a close reading of the monthly indicators has shown recently.

Nonetheless, the macro bears will seize on today's GDP report as evidence that the economy entered a new recession in Q4. But that still looks like a long-shot claim based on a broad array of economic numbers, including today's January jobs data from ADP. In addition, several December reports delivered upbeat news, including housing starts, industrial production, and retail sales. Keep in mind too that a broader view of the business cycle via the Chicago Fed National Activity Index is also signaling modest growth through December.

Does today's Q4 GDP report contradict the encouraging news from other macro metrics? More precisely, does the dramatic fall in defense spending, along with a quarterly retreat in inventories and exports, overwhelm the slow-growth trend in much of the private sector that's persisted in recent months? I'm skeptical.

This much, however, is clear. If today's dark headline GDP number is a true reflection of the macro trend, the negative signals will start showing up in the January indicators. For the moment, there's no sign of deterioration, as the January ADP Employment report implies. That's only one number, of course, but more are coming, starting with tomorrow's personal income and spending report and fresh numbers on jobless claims. Friday, of course, brings word of the Labor Department's estimate of nonfarm payrolls, followed by the January report for the ISM Manufacturing Index.

Is the Q4 GDP report telling us that we've been blindsided by otherwise upbeat economic news? Doubtful, but if we've been hoodwinked we'll know fairly soon. Stay tuned….