Looking at the year-to-date gains in the major indexes, the Russell 2000 is still showing the largest rise - +8.4 percent. This is followed by the Dow Jones Industrials, which are up 5.2 percent from year-end. The S&P 500, which also measures the large cap blue chip sector, is up 2.6 percent, while the Nasdaq composite index is up a mere 0.2 percent from year end levels.

BONDS
The bond market did not appear to fluctuate much this week - at least judging by the daily closes. On the whole, yields were down a couple of basis points, except for the 30-year bond, which was up a couple of basis points. Economic news was mixed and this could have contributed to the seemingly tame activity. First quarter GDP growth was revised up, but by a smaller-than-expected amount. Durable goods plunged, but this was primarily due to the volatile aircraft sector. Inflation news was not very good, but better than the CPI. The upcoming week will be filled with key indicators - including the employment report and bond investors will surely find some new nuggets of information to mull over.

Markets at a Glance

The Economy
PERSONAL INCOME & OUTLAYS - AND INFLATION
Personal income rose 0.5 percent in April, matching the previous month's gain, spurred by a 0.9 percent hike in wages and salaries. Disposable income, which excludes personal tax payments from the total and reflects take-home pay, increased 0.4 percent, also matching the March gain. At the same time, personal consumption expenditures increased 0.6 percent, slightly more than income, and this led to another drop in the personal savings rate.

Since monthly figures can be skewed by special factors, it is useful to look at the 3-month moving average of many economic indicators. The chart below compares the 3-month moving average of year-over-year growth in disposable income and personal consumption expenditures. Notice that personal consumption expenditures have outpaced income by a wide margin since January 2005. In part, this reflects the fact that consumers were financing their spending by cashing out home equity. The last time this gap (between income and consumption) was so wide was in 1999, just before the stock market crashed. At that time, consumers were spending more than they earned because they felt wealthier due to the rising values of their stock portfolios. Notice that spending and income were more closely aligned between 2001 and 2004. Now that interest rates are rising, and home values may be appreciating at a much slower rate, consumers will not be able to finance spending out of their home equity. We will start seeing a better alignment of income and spending. But it will mean a slower spending path by consumers.

The Fed is not following an explicit inflation-target yet. However, many Fed governors and district bank presidents have spoken about a comfort level with inflation in the 1 to 2 percent range as measured by the core PCE deflator. Notice that the PCE deflator typically runs below the consumer price index because of the different weights used in each of the measures. They do utilize the same underlying price data however. When the CPI was reported last week, investors were quite alarmed with the hike in the core CPI. This week, investors did not focus as much on the PCE deflator gain, even though it put the core index above the 2 percent rate. In any case, with the core PCE deflator outside the implicit target zone, Fed officials have to be at least somewhat worried about inflation. Of course, it is useful to keep in mind that monetary policy takes a longer time to affect inflation than to impact the real economy. That means we are starting to see the economy, but not the rate of inflation, moderate. The Fed will need to be very careful with its deliberations at meetings this summer. Thus far, the majority of economists believe the Fed will raise the funds rate target in June, but more (than a few weeks ago) are getting on the "pause" bandwagon.

HOME SALES
Existing home sales fell moderately while sales of new homes increased moderately. However, existing homes make up the bulk of the market and total home sales were down in April. While there is no question that home sales are down from year ago levels, it appears that the selling pace has remained in a small range since last December. Consumers are reacting to the rising interest rate environment, of course. Mortgage rates are roughly 100 basis points higher than the (recent) low reached a year ago. (Rates were actually at their lowest in June 2003, three years ago.) Some housing market indicators, such as the NAHB/Wells Fargo housing market index, has shown sharp deterioration lately. And this means that home sales are likely to soften in months ahead. Economists working in the real estate industry continue to believe that the slowdown will not turn into a housing market recession, but merely a more sustainable pace of activity.

REAL GDP GROWTH REVISED HIGHER
The Commerce Department's preliminary estimate showed that real (inflation-adjusted) GDP expanded at a 5.3 percent rate in the first quarter, up sharply from the 1.7 percent pace recorded in the fourth quarter, and about 0.5 percentage points higher than the initial estimate reported last month. Both personal consumption expenditures and business fixed investment were revised down from the advance report, but at 5.2 percent and 13.1 percent, respectively, the growth rates were still robust. Residential investment spending grew at a 3.1 percent rate, on par with the fourth quarter, and significantly slower than the previous year. The Commerce Department found more inventory accumulation in the first quarter than initially anticipated and it remains a question whether or not the inventory building was planned or undesired. While there is no question that final sales grew at a robust 5.5 percent rate, everyone is predicting slower growth in coming months. Perhaps inventory building will moderate as well. On the foreign front, net exports were a smaller drag than the advance report since exports grew more rapidly and imports expanded less rapidly than the initial estimate. All in all, the first quarter figures were healthy. But private sector economists as well as Fed economists & officials don't believe that this pace is sustainable.

The level of after tax profits increased to over 1.2 trillion dollars in the first quarter and were up 20.1 percent from year ago levels. Notice the blistering pace of profit growth over the past couple of years. Even with the negative impact of hurricanes Katrina, Rita and Wilma, profits have been fairly robust. The hurricanes dampened profits in the third quarter of 2005. The question that equity investors must decide for themselves is whether or not the growth rate can continue in the upcoming year. Slower GDP growth tends to generate a slower path for profits as well. But as long as GDP growth is positive, profits should continue to climb also.

APRIL ORDERS DROP
Durable goods orders declined 4.8 percent in April, reversing two-thirds of March's 6.6 percent gain. Just like outsized gains are usually caused by spurts in aircraft orders, outsized declines are due to decreases in aircraft orders. The aircraft sector is going strong, and the month-to-month fluctuations are just noise. Excluding transportation, new orders fell 1.1 percent in April, spurred by a sharp 10.4 percent plunge in computers & electronics. Other categories actually performed better in April. For instance, new orders for primary metals increased 3.2 percent; fabricated metals rose 1.9 percent and electrical equipment & appliances jumped 5.2 percent. The drop in computers should not be discounted, and could become a concern if repeated, but the April gain was simply reversing a 12 percent hike from March. On the whole, even though the average change in total new orders is -0.5 percent for the first four months of the year, it does not necessarily reflect a weak manufacturing sector, yet.

The Bottom Line
Economic indicators were mixed this week as the Commerce Department's revised estimate for GDP showed stronger growth than initially estimated. However, the first quarter is long gone and market players are now focusing on the current quarter, as well as the next one. The personal income and outlays report revealed that consumers are slowing their spending. Market players didn't pay as much attention to the PCE deflator as might have been expected in light of last week's inflation scare (by the CPI). On the whole, market players and economists are taking a wait & see attitude - particularly since many key figures will be out in the upcoming week - including the all-important employment situation on Friday.

Looking Ahead: Week of May 29 to June 2

Tuesday
The Conference Board's consumer confidence index increased 2 percentage points in April to 109.6. This was in contrast to the University of Michigan's consumer sentiment index, which has declined recently. However, these two surveys can be at odds with one another. In any case, accelerating inflation tends to be a drag on confidence.

Consumer confidence Consensus Forecast for May 06: 101
Range: 96.5 to 104.5

Wednesday
The NAPM-Chicago's business barometer decreased 3 percentage points in April to 57.2. This index, which measures both manufacturing and non-manufacturing activity in the Chicago region, is often considered a leading indicator for the ISM manufacturing index. Its monthly changes are often larger in magnitude than the ISM index.

NAPM-Chicago Consensus Forecast for May 06: 55.8
Range: 53 to 59

Market players will be waiting on pins and needles to read the May 10 FOMC minutes. Remember, that the post-meeting statement was slightly altered from the previous meeting and it is likely that some interesting tidbits will emerge from this meeting.

Thursday
New jobless claims dropped 40,000 in the week ended May 20 to 329,000, but the 4-week moving average increased to 337,000. The sharp variation in the two most recent weeks was due to issues in Puerto Rico that have now been resolved.

Jobless Claims Consensus Forecast for 5/27/06: 320,000
Range: 305,000 to 337,000

The Labor Department initially estimated that nonfarm productivity rose at a 3.2 percent rate in the first quarter, after decreasing slightly in the fourth quarter. Given the upward revision to first quarter GDP growth, it is likely that productivity growth will also be revised up. Typically an improvement in productivity comes in tandem with an improvement in unit labor costs, that is, unit labor costs should grow more slowly as productivity grows more rapidly.

Nonfarm Productivity Consensus Forecast for Q1 06: 3.8 percent rate
Range: 3.7 to 4.4 percent rate

Unit Labor Costs Consensus Forecast for Q1 06: 1.9 percent rate
Range: 1.3 to 2.3 percent rate

The ISM manufacturing index rose 2 points in April to 57.3 from March's level. The New York Fed's business outlook survey fell in May, but the Philadelphia Fed survey edged up modestly during the month. These two indicators are considered leading indicators for the ISM survey.

ISM Manufacturing Index Consensus Forecast for May 06: 56
Range: 54 to 58

Construction spending increased 0.9 percent in March, posting the ninth consecutive monthly rise. April construction could be down based on the recent declines in housing starts.

Construction Spending Consensus Forecast for Apr 06: 0.2 percent
Range: -0.8 to +0.7 percent

Domestic motor vehicle sales fell 1.6 percent in April to a 12.7 million-unit rate after declining by a similar magnitude in March. Domestic cars were sold at a 5.4 million-unit rate in April while light trucks were sold at a 7.3 million-unit rate.

Domestic Vehicle Sales Consensus Forecast for May 06: 12.7 million-unit rate
Range: 12.4 to 13.0 million-unit rate

Friday
Nonfarm payroll employment increased 138,000 in April. This was the smallest monthly gain in several months. The civilian unemployment rate remained unchanged at 4.7 percent in April and remains at historically low levels. Fed officials are concerned that the jobless rate is reflecting tight labor markets, which could potentially set the stage for rapidly accelerating wage gains.

Nonfarm Payrolls Consensus Forecast for May 06: 180,000
Range: 150,000 to 250,000

Unemployment Rate Consensus Forecast for May 06: 4.7 percent
Range: 4.6 to 4.8 percent

Average Workweek Consensus Forecast for May 06: 33.8 hours
Range: 33.8 to 33.9 hours

Average Hourly Earnings Consensus Forecast for May 06: 0.3 percent
Range: 0.0 to 0.4 percent

Factory orders jumped 4.1 percent in March, spurred by a surge in durable goods orders. New orders for durable goods plunged 4.8 percent in April as aircraft orders declined for the month. Many of the key categories posted gains, but new orders for computers & electronics plunged for the month.

Factory Orders Consensus Forecast for Apr 06: -2.2 percent
Range: -0.5 to -2.8 percent