Shrugging Off 1.3% GDP Growth

Why did the markets shrug off worse-than-expected real GDP growth of 1.3%?

Exhibit A: The Dow Jones Industrial Average rose 15.44 points to 13120.94 on Friday, hitting its third straight record to end the week. The blue-chip average has risen 19 of the past 21 days, an extremely rare streak, in spite of the GDP report.

GDP specifically measures U.S. output/production of goods and services in a given quarter, which is different from U.S. consumption of goods and services in a given quarter, and different from U.S. disposable personal income (after-tax) in a given quarter.

How would best measure your own standard of living from quarter to quarter? Probably by your household's disposable, after-tax income, and/or your household's consumption. By both measures, you are probably doing pretty well.

As the top graphs above show, inflation-adjusted disposable income increased by almost 3% in each of the last three quarters (and above the 2.4% 6-year average), and inflation-adjusted consumer spending increased by 2.66% in the first quarter 2007 (see bottom chart), compared to 2.52% overall in 2006.

Factors contributing to weak real GDP growth in the first quarter were: a) U.S. exports fell by 1.2% (production) and imports increased 2.3% (consumption), which is negative when measuring GDP production, but positive when measuring consumption and our real standard of living, b) federal government spending decreased 3.0% in the first quarter of 2007, after rising in the fourth quarter of 2006 by 4.6%, which is negative when measuring GDP production, but not necessarily bad overall that government spending fell, c) inventories decreased, which is negative for GDP production, but not necessarily detrimental to our standard of living, and d) home construction dropped 17%, which is negative for GDP production, but positive when considering a better balance between supply and demand for new housing.

Bottom Line: Weaker-than-expected growth in output doesn't necessarily translate into lower disposable income or weaker consumption spending or a weaking economy, as the recent quarter demonstrates. Unemployment is at a 6-year low and 18 states have set record low jobless rates in the last year, so the economy is strong. The record-high stock market seems to agree.