US economy is contracting but stocks hit record

People walking in Times Square, New York Image copyright AFP

The US economy is contracting for the first time since 2011. The growth rate for gross domestic product (GDP) in the first three months of the year was revised down from an annualised pace of 0.1% to a contraction of 1.0%.

Yet, the US benchmark stock index - the S&P 500 - rose to a record high, climbing 0.5% to close at 1,920 on the day.

The prospect of the world's largest economy contracting is worrying, but this is a negative quarter caused by short-term factors.

The contraction is largely due to a downward revision to private firms' inventories.

Besides, the economy wasn't performing well in any case. The first estimate of GDP was stagnant due to bad weather. The revision to inventories just pushed it into negative territory which the economy was already on the cusp of.

Freezing conditions closed factories and construction sites as well as affected stores.

Investment dropped by 1.6% - spending on buildings, housing, equipment all decreased - but spending on intellectual property rose. The latter isn't affected to the same extent by weather as the others.

There was also a negative impact on the production of exports, which fell by 6%. Imports rose by 0.7% as consumers were still buying.

Consumption increased by 3.1%, including durable goods such as dishwashers which is an indicator of people having more disposable income to spend. The federal government also continued to spend, though state and local governments cut back.

Then, the change in the inventories subtracted a sizeable 1.6 percentage points from GDP.

Measuring what companies stockpile, which includes raw materials and unfinished products, revealed that businesses increased inventories by $49bn (£29bn) in the first quarter, which was less than half of what they added in the prior months.

So, private inventories didn't grow but took away from the growth rate of economic activity.

The inventory effect is arithmetic and hits GDP due to how stockpiling is measured.

So, the US also measures GDP based on final sales, or GDP excluding the change in inventories, which increased by 0.6%. It's an attempt to get at the underlying economic activity since inventories are a short-term factor.

And as demand recovers from the bad weather, businesses are expected to raise production since inventories will run down.

It's perhaps why jobs continue to grow despite the contracting economy.

Non-farm payrolls, the awkwardly named but important indicator of jobs, rose by 569,000 in the first three months of the year, and April alone saw 288,000 jobs added. That is the most jobs created in three years since employment started recovering after the recession.

So, some economists are raising their forecasts for GDP growth in the second quarter up from the consensus of an annualised growth rate of 3.5%.

A rebound was what happened after GDP contracted by 1.3% in the first quarter of 2011. The second quarter registered growth of 3.2%.

Short-term factors like bad weather and inventories are perhaps why markets don't seem concerned. They are also buoyed by strong corporate profits, which totalled $1.88 trillion or 11% of GDP in the first quarter.

Still, overall, the recovery isn't impressive. It is unusual to have a negative quarter of GDP outside of a period of recession. Yet, the US has had two such negative quarters in the five years since the crash.

Even though it is unlikely that the US will fall into a second recession - which is technically defined as two consecutive quarters of negative GDP - these negative quarters are a reminder of how hard it is to have a sustained recovery after a systemic banking crisis.