March 30, 2017 Reading Time: 2 minutes

Final estimates from the Bureau of Economic Analysis show real gross domestic product rose 2.1 percent in the fourth quarter of 2016 and 1.6 percent for all of 2016. Those results hide stronger performances in key domestic segments of the economy. Domestic demand, or real  final sales to private domestic purchasers, comprised of consumer spending, business fixed investment, and residential investment, rose a robust 3.4 percent in the fourth quarter and 2.3 percent for all of 2016. Since 1985, domestic demand has increased at an average of 3.0 percent per year.

Consumer spending rose 3.5 percent in the fourth quarter and 2.7 percent for the year. That gain was led by spending on autos and home goods. Looking ahead, consumer spending is likely to remain relatively strong as more jobs are created, wages rise, and confidence remains high.

Business investment rose just 0.9 percent in the fourth quarter but fell 0.5 percent for all of 2016. Weak capital spending has been one of the surprise developments over the past several quarters, but the collapse of energy prices and subsequent drop in energy investment accounts for a large portion of the weakness. The AIER Leaders index shows real new orders for core capital goods (nondefense capital goods excluding aircraft) have started to rise after several months of decline. With higher levels of economic activity and somewhat higher energy prices, overall business investment should improve throughout 2017.

Residential investment, or housing, posted a strong 9.6 percent gain in the fourth quarter and 4.9 percent rise for the year. Housing, particularly single-family construction, has recovered somewhat slowly throughout the economic expansion but may be gaining some momentum. Strong consumer fundamentals, a tight supply of houses on the market, and the threat of potentially higher mortgage rates may entice people to accelerate home-buying plans.

The weak components of GDP remain trade and government. Net exports subtracted 1.8 percentage points from GDP growth in the fourth quarter. For all of 2016, net exports reduced total GDP by about 0.1 percentage points. A strong dollar remains a hurdle for U.S. exporters, but stronger global growth outside the United States may help. The strong dollar and strong consumer spending should continue to boost imports and provide very tough competition for domestic producers.

Government spending rose 0.2 percent in the final quarter and 0.8 percent for the year. The looming debt ceiling battle and ongoing deficits are likely to rouse deficit hawks, and talk of big increases in infrastructure spending creates the likelihood of prolonged budget battles in Washington.

The report on GDP also shows that price pressures have increased a bit recently. Overall, price increases remain tame by historical measures.  Much of the recent increase has come from the partial rebound in energy prices. Housing prices continue to exert upward pressure as well.

The solid performance hidden among the details of the latest report on GDP combined with the better readings from the AIER Leaders index suggest the outlook for the economy over the next couple quarters is positive. The primary risk lies in Washington, where issues such as health care reform, tax reform and the debt ceiling could devolve into a political embarrassment and cause a precipitous drop in confidence for consumers, businesses and investors.

Robert Hughes

Bob Hughes

Robert Hughes joined AIER in 2013 following more than 25 years in economic and financial markets research on Wall Street. Bob was formerly the head of Global Equity Strategy for Brown Brothers Harriman, where he developed equity investment strategy combining top-down macro analysis with bottom-up fundamentals.

Prior to BBH, Bob was a Senior Equity Strategist for State Street Global Markets, Senior Economic Strategist with Prudential Equity Group and Senior Economist and Financial Markets Analyst for Citicorp Investment Services. Bob has a MA in economics from Fordham University and a BS in business from Lehigh University.

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