First quarter GDP revised down
The Commerce Department revised down its estimate of real GDP growth, reporting that the economy expanded at a modest 1.3 percent rate in the first quarter. This is only marginally better than the 1 percent growth pace for the fourth quarter of last year. There is a contrast from the fourth quarter to first quarter periods, however. In the fourth quarter, real final sales increased at a modest 1.7 percent rate, but in the first quarter, final sales surged to a 4.4 percent rate. In the fourth quarter, inventories were built at a slower pace (but remained positive); in the first quarter, inventories were actually liquidated.

Inventories grew rapidly when real GDP accelerated in 1999 and early 2000, allowing consumer and business demand to be satisfied. As final sales moderated over the past year, producers realized they needed to reduce inventories. Indeed, Chairman Greenspan has discussed the inventory adjustment cycle several times over the past six months. An inventory correction is underway - given the actual liquidation of business inventories in the first quarter. The fact that final sales expanded so much more rapidly than real GDP implies that demand may be on the mend. Historical experience has shown that when real final sales grow more rapidly than real GDP for two quarters or more, it is likely that GDP growth will accelerate.

The composition of GDP showed that personal consumption expenditures increased at a moderate 2.9 percent rate, boosted by a surge in durable goods spending (motor vehicles). Nonresidential fixed investment increased at a modest 2.1 percent rate after remaining virtually unchanged in the fourth quarter, but a 17.2 percent spurt in structures masked a 2.6 percent drop in equipment and software investment spending. This was the second straight quarterly drop in this component. Greenspan indicated that this investment decline may continue for more than a few months, although he is confident that investment expenditures will eventually turn around. But the durable goods figures (see below) aren't suggesting any imminent upturn.

The lackluster figures are certainly friendly news for the bond market, as the data implies the Fed may continue to ease. But equity investors are faced with other issues. As long as the economy is so anemic that it can't generate improved revenues, then weak data is bearish news. After-tax corporate profits declined 2.3 percent in the first quarter after posting a 5.7 percent drop in the fourth quarter. On a year-over-year basis, (as depicted in the chart below), corporate profits fell 4.3 percent in the first quarter, just about wiping out the previous quarter's gain. If GDP remains in a modest growth path over the next couple of quarters, which most economists are predicting, then the outlook for corporate profits remains murky. Indeed, most investors have already factored in profit declines for the second and third quarters. A revival in GDP could shift sentiment, but growth ahead would have to exceed 4 percent or so for a better profit picture.

Alan Greenspan noted that the Fed has front-loaded its easing program to allow better economic growth prospects for the second half of the year. It remains to be seen whether profits will improve faster than expected. However, do look at the chart above. You'll see that corporate profits correlate quite well with the yearly change in the Dow Jones Industrials (with a lag). This suggests that we're more likely to see further profit deterioration before we see improvement.

Durable goods decline again
New orders for advance durable goods dropped 5 percent in April, pretty much reversing the gains of the previous two months. In February and March, aircraft orders surged, helping to boost the total, but this was reversed moderately in April. Excluding the volatile component, new orders were generally sluggish. New orders for primary metals have now declined in 9 of the past twelve months; similarly, new orders for industrial machinery have decreased in 9 of the past 10 months. More recently, new orders for computers and related products fell in five of the past seven months.

The chart below depicts the year-over-year change in durable goods and nondefense capital goods orders (a leading indicator for capital spending). The sharp downward trend does not show signs of imminent reversal. This suggests that the industrial sector remains in the dumps, or put differently, in recession.

On a technical note, the Census Bureau is now reporting orders, shipments and inventories data on a NAICS (North American Industrial Classification System) basis. This is an improved system from the old SIC classification, providing more information for various industries and sub-sectors. Read our Short-take on NAICS, published Wednesday, May 23. One disadvantage is that we don't have the long history of data we had before, but this is outweighed by the greater detail that will be available.

Home sales dip
New home sales dropped 9.5 percent in April and existing single-family home sales decreased 4.2 percent for the month. Every month, we have written about the surprising resiliency in the housing market and the chart below still shows a pretty strong pace of activity even after the April decline.

Ironically, interest rates have picked up in the past couple of months despite the fact that the Fed has cut the federal funds rate target by 250 basis points. The fact of the matter is that mortgage rates are tied to Treasury securities. Yields on the 10-year note have increased the past few months even as short-term rates have declined. But it is hard to make the case that a modest rise in mortgage rates (it's barely noticeable in the chart above) caused such a drop in April home sales.

Perhaps consumers are becoming more cautious in their home buying as they see the industrial sector mired in recession and layoff announcements (and the unemployment rate) on the rise. Some housing experts are even claiming that home sales were down because the supply of homes has diminished and homebuyers aren't finding what they want.

Fed officials have cited the housing market as a sign of strength compared to other sectors of the economy. It would be disconcerting if this sector were all of a sudden to fall apart in the midst of aggressive easing. One month doesn't make a trend and even if home sales fall moderately in the next couple of months, there is no question that the overall level of activity would still be high by historical standards.