GDP contracts 5.7 percent in Q1 on plunging demand, investment

Optimistic investors may want to view the Q1 U.S. GDP report this way: the worst is likely behind us, from a GDP decline standpoint.

The nation's economy contracted a revised 5.7 percent in Q1, following a 6.3 percent contraction in Q4 2008, the U.S. Commerce Department announced Friday, as the world's largest economy suffered large declines in investment, exports, and domestic demand.

In Q1, business investment plunged 36.9 percent, after-tax corporate profits plummeted 15 percent, and residential investment sank 38.7 percent. A Bloomberg News economists survey had expected Q1 U.S. GDP to decline 5.5 percent. The U.S. economy contracted 6.3 and 0.5 percent in Q4 and Q3 2008, respectively. For all of 2008, the world's largest economy grew a scant 1.1 percent, well below capacity.

Worst U.S. contraction since 1982

What's more, in the past four quarters, U.S. GDP has fallen 2.5 percent -- the economy's most severe contraction since 1982. In current-dollar GDP terms, U.S. GDP fell to $14.01 trillion in Q1.

Ryan Sweet, a senior economist at Moody's in Pennsylvania, argued that the U.S. economy is healing, but the recovery process will be incremental, and hardly robust.

"The recession is gradually moderating, but the road to recovery will be difficult," Sweet told Bloomberg News Friday. "The recession should end late this year."

One factor weighing on GDP: corporate profits, with after-tax profits plunging 15 percent in Q1 -- that metric's largest decline since 1981.

Another headwind for the economy? Slack domestic demand. U.S. consumers' purchase of goods and services fell at an annualized rate of 7.5 percent in Q1 -- that category's largest decline since 1980.

Further, the slide in exports continued in Q1, plummeting 28.7 percent, as foreign demand dried-up amid the global recession.

Some positives in Q1

Still, there were some positives in the Q1 GDP report. The saving's rate, for many years too low in United States, rose to 4.4 percent.

However, economists caution that, in the short term, the higher than normal savings rate will reduce demand, weighing on GDP. Long term, it should boost investment and aid business development.

Also, consumer spending rose 1.5 percent in Q1 after falling at a 4 percent annualized rate over the previous six months. If consumer spending continues to rise, that would represent another 'green shoot' for the economy, most economists agree. In addition, Inventories fell by $91.4 billion, suggesting that the nation is working off excess supply, setting the stage for increased production in subsequent quarters.

The global economy is still coping with weak industrial production, shrinking world trade, and high unemployment. Those factors, in and of themselves, will not drive U.S. GDP, but as a long-time watcher of economics once observed, "That's not a good start."

Also likely to complicate the U.S. recovery: the high (for the economic cycle) and rising price of oil, which shot through $66 per barrel Friday. High inventories, increased production capacity, and flat/declining demand all call for a low oil price, but the oil market has ignored them, arguing that an economic recovery in Q3/Q4 will boost oil demand. Ironically, that higher price will end up weighing on GDP growth, most economists agree, if it remains above $60 per barrel: high oil prices serve as a de facto tax on consumers/businesses in most industrialized nations.

Economic Analysis: Viewing the glass as half-full, there were some positives in the Q1 GDP report, including the work-down in inventories and the uptick in consumer spending. By and large, despite the large declines in exports and investment, U.S. stock markets should interpret the Q1 report as another sign of an approaching economic bottom. That said, a bottom does not equate with the arrival of a growth engine(s) to propel a substantial, sustained recovery. That fact, plus the likelihood of rising unemployment through at least Q2 2010, point to slow, tepid GDP growth, at least at the outset of the economic recovery.

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