Ignore the Topline GDP Number

As we wrote last week: ignore the GDP headline, which was likely to be weak, but misleading.

As it turns out, the headline was even weaker than we thought, coming in (slightly) negative for the first time since 2009 and lower than any forecast from the 83 groups making predictions. We thought inventories would subtract 1.3 points from the GDP growth rate and got that exactly right, but government purchases also subtracted 1.3 points from the growth rate of real GDP, due to the largest drop in defense (relative to GDP) since the wind-down in Vietnam in 1973.

The 0.1 percent annual rate of real GDP contraction is misleading because the key components of GDP — personal spending, business investment, and homebuilding — were all rising, and came in at a combined 3.4 percent annual growth rate, exactly as we forecast. Reductions in inventories and government purchases may hurt in the short run, but looking ahead to 2013 we think these cuts are a positive: Lower inventories mean more showrooms and shelves to be stocked; less government spending means lower deficits and the potential for lower taxes (or fewer future tax hikes).

For now, we maintain our forecast that real GDP will grow in the 2.5 percent to 3 percent range in 2013, but think the chance of an upside surprise modestly outweighs the risks of a disappointment.