Why Wall Street Is Projecting Slower Growth The economy is growing, slowly but steadily. People are buying more houses, more cars, and feeling better about their economic situation than they have in years. The fiscal cliff, while causing the occasional heart attack on business news networks, has had no measurable impact on the real economy. The Dow Jones Industrial Average is above 13,000. So why are economic forecasters so glum about the fourth quarter? A pedestrian passes in front of the New York Stock Exchange on Dec. 5, 2012. Scott Eells, Bloomberg / Getty Images Well, a lot of it has to do with how GDP is calculated and an anomalously high reading in the third quarter. The most recent revision of GDP growth for the third quarter bumped it up from 2 percent to 2.7 percent - that's more than twice the rate of second quarter growth. The Commerce Department raised the estimate for third quarter growth in part because of a revision to business inventories. That's the amount of stuff businesses buy every quarter that they then hope to sell. A sharp revision in the rise of business inventory, up to $61.3 billion, contributed an extra .77 percent from the initial reading to the revised one. Now, for economic growth to remain at that high level in the fourth quarter, inventories would have to stay at that high level. And very few economists think they will. "We had such a massive buildup, firms will be doing much less in terms of inventory building in the fourth quarter and that's a drag on growth," said Omair Sharif, an economist at Royal Bank of Scotland, which recently knocked down its fourth quarter GDP forecast from 2 percent to .9 percent. Macroeconomic Advisors said in its latest update to its GDP projection that it expects "substantially less inventory building in the fourth quarter." That factor alone caused the firm to reduce its projection for fourth quarter growth from .8 percent to .5 percent. firms will be doing much less in terms of inventory building But why did businesses get so excited in the third quarter and add so much to inventories? One reason could be that companies expected to sell more stuff in the quarter. They expected personal consumption to be strong. If you buy a lot of inventory and demand doesn't materialize, you'll be left with a lot of stuff on hand. And it's now looking that personal consumption was actually kind of week in the third quarter, Personal consumption expenditures, a measure of consumer spending that makes up about two-thirds of all economic activity, were first reported to grow 2 percent for the third quarter. But the Commerce Department revised the rate down to 1.5 percent. With consumption lower growing at a slower pace than expected, businesses won't have to buy much in the fourth quarter they might have thought. They'll still be working down the inventory they built up in the third quarter. The second important, one-off addition to the third quarter that economists do not think will replicate itself through the end of this year was a jump in defense spending. Consumption and investment by the federal government jumped up 9.5 percent in the third quarter, after having fallen .2 percent in the second. The gain was heavily weighted towards defense spending, which increased by 12.9 percent, while nondefense spending only went up 3 percent. Ben Herzon, a senior macroeconomist at Macroeconomic Advisors, said that we are likely to see a temporary slowdown as business cut back orders to adjust for the big run-up in inventories. With defense spending slowing, "these two dynamics combined more than account for decelerating GDP growth," said Herzon. Because the economy's underlying growth is so sluggish - 1.8 percent in 2011, 2 percent annual growth in the first quarter of this year and 1.3 percent in the second quarter - just a few shocks that shave half a percent or so off the growth rate can take it down to hovering just above zero. Herzon cautioned that this whiplash in GDP projections between quarters, and the fourth quarter projection getting dangerously close to zero, does not indicate some new fundamental weakness in the economy that will restrain its growth in the future. Rather, he described the end of the year slowdown as "a temporary pause." Some cutbacks in business orders in equipment could be due to uncertainty over the final result of the fiscal cliff negotiations. But what about home and car sales, which are growing and directly reflect consumers ability and willingness to make big purchases? Sharif said that the home and auto industries just aren't big enough compared to the rest of the economy to drag growth along. Housing provides the most vivid example. Real residential fixed investment, which tracks housing's contribution to the overall economy, increased 14.2 percent in the third quarter, and jumped 8.5 percent the quarter before. However, it's only around 2.5 percent of GDP today, compared to an average 4.5 percent from 1980 to 2007and 6.3 percent of GDP at the end of 2005. Sharif explained that even if residential investment is growing at 15 percent a year, that's only good for around .3 or .4 percent of GDP growth, although increases in home prices can cause consumers to spend more outside of the housing sector. Going forward, that might be the economy's best hope.