Why the Market's GDP-Induced Drop Makes No Sense

By Markets Fool.com


Growth remained robust in the U.S. economy during the fourth quarter. Source: Bureau of Economic Analysis.

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Stock market traders are notorious for their attention to short-term influences, and this morning's fourth-quarter report on U.S. economic growth spurred a predictably negative response Friday morning. Gross domestic product rose at a healthy 2.6% rate during the fourth quarter, but economists had hoped that the U.S. economy would sustain even faster growth after soaring 5% during the previous quarter. As a result, stocks sold off, with the Dow Jones Industrials falling by triple digits within the first hour of trading. As of 11:30 a.m. EST, the Dow was down 145 points, and several other market benchmarks showed similar losses.

Yet investors ignored several potential positives contained within the GDP report. Consumer confidence showed quite clearly in the report, with consumer spending climbing by 4.3%. For years, economists have worried when consumers failed to lead the way higher with spending efforts, so now their positive influence should get more weight. Further, inflation remains a nonexistent threat, with the GDP's price deflator falling 0.5% during the quarter. Energy played a huge role in that drop, but even the core personal-consumption expenditures index rose at an annualized rate of just 1.1%, indicating that price pressures won't cause any concern in the near future.


Source: Bureau of Economic Analysis.

Some economists worried that other sources of spending showed weakness. Business spending fell 1.9%, but that followed a huge 11% jump in the third quarter. Strength in the U.S. dollar hurt exports and brought in more imports, shaving about 1 percentage point off the GDP growth rate. Government spending levels also fell. Still, given the typical negative reaction that most market participants had when the government seemed to prop up the economy with lavish spending habits, you'd think investors would be encouraged by signs that the government was playing less of a role in economic growth.

The market's reaction seems particularly inconsistent with its response to the Federal Reserve's latest indication of future monetary policy earlier this week. The Federal Open Market Committee said the economy looked like it was on track to sustain solid growth and therefore should no longer need the help of low short-term interest rates. If the GDP report paints a picture of slower-than-expected growth, however, you'd expect investors to celebrate the possibility that the Fed might prove to be more patient than expected in waiting longer to raise rates.

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Macroeconomic indicators are an important part of investing, but interpreting them in the short run is largely an exercise in futility. Because of the length of time it takes for economic trends to play out fully, overreacting to a single piece of data without putting it in the broader context of longer-term influences can lead you to make knee-jerk mistakes in choosing appropriate investments.

The article Why the Market's GDP-Induced Drop Makes No Sense originally appeared on Fool.com.

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