A Close Look at How the Economy Is Growing

The economy grew by 2.5% in the first quarter, according to Friday's report from the Bureau of Economic Analysis.

That's the early reading, at least. These reports are always revised in subsequent months. "Friends don't let friends waste too much time on the internals of a soon-to-be-revised GDP report," wrote Slate's Matt Yglesias.

But let's look at what we've got so far.

Two-and-a-half percent growth isn't strong, but it's pretty consistent with where we've been for most of the recovery over the last four years:

Source: BEA.

Some bumps here and there, but we're stuck at about 2.5% growth. That's probably enough to bring down unemployment, but just barely.

Now for some of the internal components of GDP.

Consumer spending has actually been strong. First-quarter growth was particularly impressive given the expiration of the payroll tax cut:

Source: BEA.

Earlier this year, internal emails between Wal-Mart executives hinted that consumers were being clobbered by the end of the payroll tax cut. That was, however, more speculation than proof. As more data comes out, including corporate earnings reports, it's peculiarly hard to spot the tax hike having much impact.

Fixed investment -- businesses and households investing in things like homes, buildings, and equipment -- is also healthy:

Source: BEA.

One of the big drivers here is residential construction. For years, construction was a net headwind on economic growth as construction of new homes ground to a halt. Now that building is ramping up, residential construction is adding to growth -- 0.3% in the first quarter. This will likely be a big contributor to growth going forward. It almost always does during a recovery.

Businesses tweaking around their inventories can have a big impact on quarterly GDP figures. In the fourth quarter, a large drawdown whacked overall growth. We made up most of the loss in the first quarter:

Source: BEA.

So, what's keeping growth low? Government spending (or a contraction of it) is now a significant drag on growth:

Source: BEA.

And within government, the real culprit is a decline in defense spending:

Source: BEA.

Keep in mind that there's basically no correlation between what the economy is doing today and what stocks might do tomorrow. The correlation between current GDP growth and five-year subsequent stock returns is -0.06. About zero, in other words. For three-year, forward-looking market returns, the correlation is -0.09 -- still about zero! For one-year returns, it's -0.21 -- still low. Returns of the Dow Jones will be determined by an unpredictable mesh of earnings and expectations, with almost no rational connection to quarterly GDP reports. Honest. 

The article A Close Look at How the Economy Is Growing originally appeared on Fool.com.

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