The economy reportedly grew at a 2.9% annualized rate in the fourth quarter, according to the latest GDP report from the Bureau of Economic Analysis.
The New York Times reported that today’s GDP report was solid despite fears of a recession. The US economist from Bank of America said that the economy continues to motor on and that there’s a lot more momentum than we thought.
Breaking the Report Into Layers
In this article, I’m going to walk you through how to analyze the GDP report and show you why this analysis about an accelerating economy is wrong. The US economy is actually losing momentum at a rapid pace and is entering recessionary territory. Let’s understand why.
We’re going to look at the economy in layers, starting with the broadest or widest measure and then get increasingly narrow, focusing in on the most important sectors of the economy.
Total real GDP is the top layer. This is the layer that includes everything.
This includes total consumption, all investment, government spending, and net exports.
Diving Into GDP Data
It is true that real GDP increased in the second half of 2022.
I show all my charts as a two quarter growth rate rather than a one quarter growth rate because its smoother and allows you to see the trends more clearly.
Real GDP growth ended the year at 1.8%, up from 0.9% which is why people are saying the economy is improving.
But we have to dig one layer deeper to see the real story.
88% of real GDP comes from two sectors. Consumption and investment. This means 12% comes from government spending and net exports.
This 88% is the core of the economy. If we look at consumption and investment only, we see that growth hasn’t been increasing and actually remained flat in Q4. Also, the growth rate is just 0.6%. So while we’re hearing stories of an accelerating economy, that’s not true for 88% of the economy – the most important 88%.
If we stay focused on consumption and investment, and dig one layer deeper we can narrow down what parts of these sectors we want to focus on. We want to extract the parts of the economy that really drive the recessions. If we look at history, we can see that a recession is born in one of three sectors. Housing, durable goods consumption or business equipment investment.
The housing sector means the level of construction activity in the housing sector and durable goods consumption is closely related, tracking the sales of washing machines, home appliances, cars, tools and other bulky items like furniture. These two sectors turn down sharply ahead of recessions.
Business equipment is the first place that a business pulls back at the first sight of slowing sales. A business manager might decide to hold off on buying a new piece of machinery is sales are slowing down.
If we look at these three sectors together, housing, durable goods and business equipment, about 20% of the economy, we see a totally different picture. Growth is slowing down and fell deeply negative in Q4. The three most important sectors of the economy are contracting and have been for the last 3 quarters!
So what we know from this report is that main engine of the US economy, the 20% of the economy that really drives the boat, is struggling badly under the pressure of higher interest rates, inflation and weakening profits.
These sectors are also considered leading indicators meaning that the broader economy follow their direction.
Since the cyclical engine of the economy is contracting, that means it will be very hard for the broader economy to stay afloat over the next few quarters. This GDP report is much more consistent with recession ahead than it is a story about an accelerating or resilient economy.