As expected, Q3 GDP revised down
The Commerce Department's revised estimate showed that real GDP fell at a 1.1 percent annual rate in the third quarter, more than reversing the previous quarter's meager 0.3 percent gain. Personal consumption expenditures were nearly unchanged from the initial estimate while business fixed investment showed a smaller rate of decline and residential investment was revised up slightly. The major contributors to the downward revision were net exports and business inventories. Exports declined more rapidly than previously anticipated while imports fell by a smaller degree. Consequently, this added to the net export deficit. A larger deficit is a greater drag on GDP.

Business inventories were liquidating at a faster pace than initially estimated and faster than the two previous quarters. Final sales declined at a 0.3 percent rate after inching up at a 0.7 percent rate in the second quarter. The sharp pace of inventory liquidation suggests that inventories are rather lean and should be closely aligned with sales. As soon as demand picks up in the slightest amount, there will be room for production gains. Since final sales declined with inventories in the fourth quarter, production increases are not likely to occur in the fourth quarter, but farther out in the first or second quarters of next year.

The Commerce Department also included its advance estimate of third quarter corporate profits along with the GDP report. The news was not friendly as indicated in the chart below. After tax corporate profits fell 18.7 percent versus year ago profits. This was the third straight decline in profits and appears to be mirroring the profit decline recorded in 1998. Many analysts believe that corporate profits won't start to turn around until the second half of 2002. If their forecasts are realized, the profit recession would rank among the worst in the post war period.

The chart above does show that after tax profits are closely correlated with stock prices. When stock prices rise on a year-over-year basis, so do after tax profits; when stock prices are down so are profits. Since these corporate profit figures are reported with a lag, look to changes in the stock market as a leading indicator of the direction of profits.

Home sales gain in October
Total home sales rose 4.7 percent in October, nearly back to the average pace reported during much of the year. Given that mortgage rates had declined more than one percentage point (120 basis points) in October relative to a year ago, the healthy housing market is not entirely surprising. It is possible that housing activity will begin to moderate in coming months. The spurt in the Treasury yield curve led to a 25 basis point jump in the mortgage rate in the week ending November 23 and November 30 - so that the average mortgage rate was 7.02 percent at the end of November, up from a low of 6.45 percent registered in the week ending November 9.

If these rates hold, home sales will slow and homeowners may lose their motivation to refinance their current mortgage loans. A drop in refinancing activity often means that consumers are not able to generate extra discretionary income on a monthly basis. This could hamper an improvement in retail sales. Of course, this is all dependent on the fluctuations in daily 10-year Treasury note rates. If bond investors once again believe that the Fed could reduce the federal funds rate target an additional 50 to 100 basis points because the economy is sluggish, then Treasury yields would decline again and in turn mortgage rates.

Durables shoot up, but it's a volatile series
New orders for durable goods surged 12.8 percent in October, more than offsetting September's 9.2 percent drop. Excluding the volatile transportation sector, new orders rose 3.4 percent in October, not quite recovering last month's 6.4 percent decline. Not surprisingly, defense orders skyrocketed a whopping 206.3 percent in October. While this may appear related to the war on terrorism, it isn't unusual to see defense orders jump like that even during peace and calm. Since the category is generally small, a doubling of orders looks severe.

Nondefense capital goods orders, considered a barometer of capital spending, did jump 7.4 percent in October, but didn't recoup last month's 13.1 percent drop. As indicated in the chart above, nondefense capital goods orders are still down more than 20 percent relative to a year ago. Indeed, total durable goods orders are showing some improvement because of the spurt in defense, but are still down 7.4 percent overall.

Unfortunately, the September/October data period will show a permanent skew in the trend since the Census Bureau decided to ignore the normal seasonal adjustment process because of the distortions caused by the September 11 tragedy and manually adjust for seasonal variations. Indeed, this attempt to manually adjust for seasonal variation is also affecting other economic variables such as retail sales.

We should look to November and December data for confirming evidence of economic improvement. So far, the November figures aren't all that promising. Last week we saw the Philadelphia Fed's business outlook survey stay in the red, and this week it was the Chicago purchasing managers' survey. The business barometer from the PMAC survey declined to 41.1 percent in November from an already sluggish level of 46.2 in October. This Chicago index is closely monitored because the region's manufacturing distribution is similar to that of the nation. The chart shows that the PMAC survey does move in tandem with the NAPM (reported on Monday, December 3) but not always by the same magnitude. The latest figure points to a drop in the NAPM.

Looking ahead to employment
Labor market conditions aren't altogether great. The Conference Board's help wanted index, reported with a lag, showed that help wanted advertising declined sharply again in October. Yet declining in the first part of November were new jobless claims, which can help predict monthly changes in nonfarm payrolls. The improvement could suggest that nonfarm payroll employment won't decline as rapidly as in October. In fact, economists are predicting that nonfarm payrolls will decline half as much as the 415,000 drop posted for October.