The newest recovery indicators show all six at levels above those at the start of the recession, even after factoring for inflation. How can this be after a negative GDP report and an unimpressive unemployment report? The more I look at the GDP report and other analyses of it, the more it seems that the fourth quarter decline was related to anticipation of the changes in tax policy. First, the decline in GDP was primarily caused by a decrease in government spending, especially in defense; other business factors were generally good. (Click chart to enlarge)  

  Remember, calendar Q4 is actually fiscal Q1 of the Federal budget. There was increased government spending in calendar Q3 (fiscal Q4) as departments increased spending to their budget levels, so calendar Q4 spending was not as likely anyway. On average, they probably ended up as insignificant when considered together. The decline hid increases in business activity in the private sector, helped by small businesses shifting revenues into Q4 in anticipation of upcoming tax increases. As for the constant news coverage of government deficits that are increasing and out of control, hearing reports of a decrease in governments spending causing a decline in GDP does not make sense. The way GDP is calculated holds the answer: transfer payments such as Social Security and Medicare are not included in GDP. This is because they are transfers alone and are not used to produce goods, being transfers of the income of others and not new income. Looking at the ISM reports, it seems that the recent declines in manufacturing were probably affected by delayed orders as businesses worked off inventories and did not replenish them in Q4 but started to do so in Q1. This increased their profits for tax purposes in Q4. Despite the decreases in ISM non-manufacturing new orders, the rate of new orders is at a level implying a good level of growth; manufacturing orders increased. The NASDAQ had a good month despite the pullback in Apple stock. Higher tax rates make the use of Roth IRAs, 401ks, and other tax-favorable investments more rewarding. Because stocks had a difficult December, the lower prices of stocks were very attractive in January and also started to create incentives to leave bonds in favor of stocks. New retirement fund contributions for 2013 have been a contributing factor in rise of stock prices; mutual fund inflows have been strong. The Fed has been trying to force the shift from bonds to stocks for some time now, and we will only know if they are successful if the Dow and S&P 500 pass their pre-recession levels on an inflation-adjusted basis as the NASDAQ has. Because the S&P 500 has so many financial stocks, it is further from that level than the Dow. December and January sent conflicting signals as business and taxpayers made changes to their flows of activity for reasons unrelated to underlying business activity. The nature of economic conditions will become more clear in the next few reports, but overly pessimistic economic forecasts of +1.5% GDP or lower may be significantly wrong. While a +2.5% economy is disappointing and not up to historical standards, the possibility that economic levels may play out better than assumed in the near term is higher than originally conceived, and perhaps the Q4 GDP will be viewed as an anomaly a few quarters from now.