Friday's report on Q4 GDP growth was both surprising and disappointing. Yet the stock market posted a very strong day in spite of this number. Why?
First for the GDP number. The reported growth rate, 1.1 percent, is much smaller than what was expected (around a 2.6% rate). But examination "below the surface" of this number reveals some trends that are either one-time in nature or just plain incorrect. Government spending fell at a double-digit rate from Q3 to Q4. What's the probability of that repeating? Not much. Also, the amazing car sales prompted earlier in the year by major discounts essentially "stole" sales from the end of the year, making the Consumption growth rate much slower than is realistic to expect for this year. Then there is the fact that Friday's number is preliminary, using ESTIMATED values for Net Exports and Inventories. These may also be revised in the next two relases of Q4 data.
So, why the stock market response? Other things being equal (which we spoke about in class on Thursday), this should have hurt stock prices. But "other things" are seldom equal. Housing data released the same day were encouraging. Several large companies reported strong earnings. But, in a sense, the GDP number itself was a "win-win" for the stock market. IF it is correct, then the clear implication is that the Federal Reserve will have almost no further tightening to do. This is beneficial to stocks, since rising interest rates are bad for stocks (we will go over the reasons in class over the next two weeks). But assuming this growth rate is too low, which is a very safe bet, this implies profits, which are a fundamental driver of stock prices, have remained strong going into 2006. And the stronger are profits, the higher stock prices tend to move (other things being equal, of course).
We will cover this topic in detail on Tuesday. Make sure you bring the Online Notes for GDP to class with you.
