Latest GDP Surprise

Third quarter economic activity grew at 2.0 percent, which is decent but still subpar compared to the historical norm.  Gross Domestic Product (GDP) generally grows by three percent on average and should be growing closer to four to five percent after a recession in order to compensate for the losses during the recession.  So no one is happily cheering the latest figures.

Diving into details, there was one big surprise in the components.  Defense spending grew at a whopping 13 percent.  The timing of the spending is likely the cause for this huge jump.  But because of it, GDP was boosted by more than 0.6 percentage points.  In other words, had the defense spending showed a mild decline as had been the case in prior quarters then the overall GDP would have been crawling at 1.4 percent growth (and not at the more respectable 2.0 percent growth).   This surge in defense spending cannot occur in the fourth quarter and will revert back, which means that the upcoming fourth quarter GDP will get cut by around 0.5 percentage points.  Therefore, there looks to be another subpar economic performance coming in the next quarter.

There were no big surprises to other components.  Consumer spending grew at 2.0 percent.  Business spending did not grow despite huge cash holdings and elevated corporate profits.  This was however expected since the ‘fiscal cliff’ contingencies are still a probability.  Net exports barely moved.  State and local government cut spending modestly.  The one strong positive, aside from defense spending, was spending related to housing.  Residential investment spending grew solidly by 14.4 percent.  Without defense and without housing, the economy would be on the edge of another fresh recession.  Thank goodness the housing market is recovering just at the needed time.

The forecast for upcoming quarters is shown in the attached table.  This forecast was released on Thursday before the GDP announcement, but the underlying supporting factors for economic outlook remains largely the same.  Quickly summarizing:

• Another subpar economic growth period in the fourth quarter
• GDP speeds up modestly in 2013, meaning faster job growth.
• Mortgage rates will be a tad higher, though nothing alarming.
• Existing home sales will rise by 8 to 10 percent in 2013.
• Home prices will grow by 5 percent.
• Housing starts will significantly kick higher by nearly 50 percent next year.

The forecast will be off no doubt, but based on what we know as of today and the likely path of the housing recovery, the overall economic situation will be a bit brighter next year.  The forecast assumes no fiscal cliff.

Quarterly Forecast table > (PDF)