As the saying goes, you can’t always judge a book by its cover.
Taken at face value, the news that the economy grew at only a 1.9 percent annualized pace in the fourth quarter could be viewed as further evidence of an economy that has struggled to break free from the negative effects of a stronger dollar and declines in oil prices.
After all, the economy grew at 3.5 percent in the third quarter; should today’s data be viewed with concern that the economy is slowing again? We don’t think so.
{mosads}Starting with the more obvious good news, private consumption grew at a 2.5 percent annualized rate in the quarter.
While this represents a slowing from the more robust rates of household spending growth in the previous two quarters, anything around 2.5 percent or better on consumption is a good number.
What households spend on goods and services is more than two-thirds of economic activity, and this growth in spending starts the economy on the right foot. Smoothing through some of the volatility in the quarterly data, household spending is up 2.8 percent year-on-year. Not bad.
The other obvious good news came from housing, where residential investment snapped back after two quarters of declines and grew by an annualized rate of 10.2 percent.
Housing has been volatile of late, and it remains an open question as to how well the sector will stomach the back-up in mortgage rates since the presidential election in November. But the sector showed good momentum at year-end.
The obvious not-so-good news came from business investment, which was soft yet again. Throughout much of the recovery, businesses have been reluctant to invest in property, plant, and equipment without tangible evidence that the economy was growing faster.
Data that track spending on equipment and software, intellectual property investment, and structures were generally uninspiring. But this is not a new story, and business investment contributed positively to growth in the quarter.
What took headline growth lower in the quarter? Trade. Imports grew at an annualized 8.3 percent pace, while exports fell 4.3 percent. Measured growth is dependent on the difference between exports and imports, since the former adds to domestic activity while the latter subtracts.
The surge in imports, alongside a contraction in exports, meant net trade subtracted 1.7 percentage points from GDP growth in the quarter. Imports have to go somewhere — they are either consumed or counted as inventory.
In this case, they went mainly into inventories. Adjusted for inflation, private inventories grew $48.7 billion in the quarter, adding 1.0 percentage point to growth. This helped offset some of the weakness from trade.
So why do we take a positive signal from a large drag in trade? The main reason is what we imported. For much of the last year, domestic demand in the U.S. was fairly solid, driven by household spending. Yet imports of consumer and capital goods (outside of autos) were weak.
History suggests these two trends will not persist, and the question is which data are sending the correct signal. Will private demand slow because import data are saying demand is weakening, or will imports pick up to match domestic demand?
Today’s economic data suggest the latter is true. Imports of consumer and capital goods were up a robust 16.5 percent and 6.7 percent, respectively, in the quarter.
Hence, while this means net trade dragged headline growth lower, we believe the import data tell us the underlying fundamentals of the U.S. economy look just fine.
Strong imports of consumer and capital goods mean household and business spending remains healthy and the expansion should continue. It is also why we think an underwhelming growth number actually has a silver lining for momentum in 2017.
Michael Gapen is the chief U.S. economist at Barclays.
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