The truth behind conflicting US data

The world’s largest economy has been giving off mixed signals over the last week or two. American gross domestic product contracted in the first quarter of 2014 but stocks are trading at all-time highs and the number of unemployment claims is in decline. How do we explain these apparent contradictions and where does the truth really lie?

On Thursday, the Commerce Department slashed its estimate of GDP to indicate that the economy shrank in the first quarter of 2014 for the first time in three years, at a 1.0% annual rate. It was a bigger drop than analysts were predicting. At first glance this is bad news, but it’s worth delving a little deeper. The GDP sank as inventories were down and the trade deficit was up. These facts do not reflect a long-term trend, but show that the temporary hit to the economy caused by the icy weather and blizzards at the end of 2013 had a deeper impact than economists previously anticipated.

Companies were deterred from restocking their inventories and cut back on investments, but reality dictates that inventories can only sink so low. Given the impermanent cause of the decline, an economic rebound seems even more likely. Businesses will be looking to restock and invest again to make up for lost revenues.

Indeed, positive monthly data already points to a turnaround in the second quarter. Jobs data, which provides a strong indication of overall economic health, was also released last Thursday. The Labor Department broke the news that applications for unemployment benefits declined 27,000 to a near seven-year low at 300,000. Consider too that consumer spending, a very significant contributor to economic activity, grew at a rate of 3.1%, and it becomes clear why investors are bullish.

Thanks to optimistic traders, and the hesitant responses of bearish traders to the positive data, the Dow and S&P 500 indices finished Friday near record highs. The S&P500 gained 3.54 points to 1,923.57, marking its fourth straight month of gains, and the Dow rose 18.43 points to 16,717.17, higher than its previous record close on May 13.

Investor sentiment, often more so than market data, reveals what’s happening in the minds of businesses and consumers. The American public seem to be confident that their economy is heading in the right direction. The markets will certainly require confirmation and further positive economic data if the bullish trends are to continue, but for now at least, it seems that the harsh winter and its impact on the start of the calendar year was an unfortunate blip that has already passed.