2014 GDP: A weak start but a strong end?

Wade Balliet
Posted by Wade Balliet
Investment Strategy

Estimates of first quarter U.S. GDP have gone down steadily. Initially, the Bureau of Economic Analysis (BEA) put GDP growth at 0.1%, however, the second estimate was revised down to a negative 1.0% annualized pace, and recently the third and final estimate came in at a negative 2.9%.

Closeup on the middle of a road, leading off into the horizon under a bright orange sunset.So, some investors may be asking: Is this the start of a downturn, or is Q1 an outlier?

The GDP revisions were far below estimates and mark the sharpest pullback in economic growth since the recession ended five years ago. But, looking at the underlying data suggests Q1 was not indicative of the economy moving forward — and the Investment Advisory & Management (IA&M) team in Bank of the West’s Wealth Management Group has now revised its estimate of GDP to 2.0% for the year.

Among the factors our IA&M team considered when assessing the Q1 GDP and looking at growth potential are:

1. Inventory reduction. The latest GDP estimate includes a sizable correction in business inventories, which by itself subtracted more than 1.7 percentage points from growth in the first quarter. This reduction is not likely to be repeated in subsequent quarters, improving the odds that business inventories will add (not subtract) to GDP growth in the coming quarters.

2. Health care spending. A large part of latest downward revision in GDP came from health care spending. The contribution of spending on health care services was revised down 1.2 percentage points. Over time, this trend may encourage greater business investment and consumer spending.

3. Net exports were lower. Exports declined at an 8.9% rate — largely attributed to the cold winter — and that decline took 1.5 percentage points from GDP growth.

4. Can you turn up the heat? The weather not only impacted exports, consumer spending on utilities surged more than 40% at an annual rate in the first quarter, the largest increase on record (with data back to 1959).

5. Consumer confidence is up. Rising home prices and household wealth, along with improving job growth, are helping to revive consumer confidence and spending.

6. Job growth. According to the Bureau of Labor Statistics, employers added 224,000 jobs in May and 288,000 in June, making it five consecutive months 200,000+ jobs were added to the economy, the first time that has happened in 14 years.

Looking ahead: Will inflation damper spending?

Looking forward although we do see positives, there are items we are watching. We do see inflationary trends that could threaten consumer spending in the months ahead. In May, consumer prices rose at the fastest pace in more than a year, and according to the Labor Department, the consumer price index jumped 0.4% in May after rising 0.3% in April. In addition, the Bureau of Labor Statistics reported that, after figuring in inflation, average hourly earnings are down 0.1% the past year.

If these trends continue, lower consumer spending could create impact GDP growth over the year, so we continue to look closely at inflationary pressures, particularly in food and energy costs. Market participants may see an uptick in inflation; however, this could be a short-term phenomenon with relief coming toward the end of the year.

However, we also note that wholesale prices fell in May, and that overall and core inflation is up about 2% over the past year, which is finally returning to the Fed’s inflation target and is consistent with a growing economy.

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