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Economy in Brief

by Bob Brusca  GDP Growth Rate is HALVED! May 31, 2007

From a low 1.3% to a tiny 0.6%... yes this is an annual rate.

PCE growth is revised UP to 4.4% from 3.8% as all of its components strengthen.

Nonresidential fixed investment is stronger at 2.9% up from 2% mostly on stronger structures.

Residential investment is stronger at -15.4% instead of -17.0%.

Inventory growth is MUCH weaker at -4.5bln from +14.8bln.

Net exports are a huge negative: -$611.8 bil from -$597.8 bil previously.

Government spending is slightly stronger at 1% from 0.9% previously.

GDP net-exports worsened by an additional $14 bil and inventories worsen by 19.3 bil for a whopping subtraction of $33.3 bil that was only partly offset by the other components where upward revisions were the rule but were small. The inventory revision was much larger than expected. It’s the first drop in quarterly inventories since Q3 of 2005.

The DROP in GDP will lower productivity and hike unit labor cost trends. But the drop is a remedial drop as inventories are much more likely to be replenished with consumer spending growth so strong and capital spending advancing. The trade result was surprising; although exports did improve, they still fell at a time when overseas growth is picking up and the dollar has been weaker. Imports were very strong, much more than GDP would have suggested. That is a bit of a surprise since much of the trade deterioration was nominal and related to rising oil prices. AND it’s clear that we were not importing nonoil goods for inventory purposes.

Another nettlesome factor is that corporate profits are in a sharp slowdown mode. That is not the signal we have been getting from the performance of the stock market, however. Moreover, weak corporate profits will restrain the potential for capital equipment spending to advance (see second char). The economy needs both consumer and capital spending to kick into gear. It also needs its trade engine to get in gear. While the consumer seems healthy and capital spending has made some comeback, the economy still faces challenges. The trend in corporate profits is one of them.

Growth prospects: While much of the battleground between economy bulls and bears has been over housing, perhaps a better battle field is capital spending. Housing’s weakness is undeniable but hardly as extreme as it is portrayed unless there is a lot more to come. By and large, housing price gains over recent years are intact and only the newcomers have been stung or face depleted equity and a lower house price. In any event, it is water under the bridge and since most the capital gains accumulated over the years for most homeowners are still intact the wealth effect seems to be positive if viewed on any sort of a lag, not negative.

For capital spending, the situation is clearer and the link to growth more straightforward. After all, housing is only 4.5% of GDP while capital spending is nearly triple that. Profitability will determine how much capital spending firms execute. With such cheap labor overseas firms are easily lured to invest outside the US. Yet without domestic investment productivity trends and consumer spending will be hard-pressed to carry on. Perhaps the stock market rise is a sign of better corporate profit days ahead. If not, that is another bubble, albeit a much smaller one, waiting to burst.

On balance, there is nothing in the GDP report that should hold back growth in Q2. The inventory correction could drag out another quarter since single quarter declines in inventories are not so common (but the last one was in 2003-Q2). Despite the weak GDP report I am made more optimistic except for the unexplained lingering weakness in US exports. GDP trends are slowing and the quarterly numbers are persistently below the Yr/Yr pace; that tells us that they are still dragging it lower. Since business investment trends seem to turning up, maybe the message there is that firms do see improved profits in the period ahead. But that is another sector to keep a wary eye on. And since firms invest to make profits (and use profits to fund further investments…) if capital spending revives we will also want to keep an eye on pricing power and the Fed’s inflation fight.

US GDP Summary
GDP GROWTH 2006Q1 2006Q2 2006Q3 2006Q4 2007Q1 2007Q1 Current
Actual/A,P,F Actual Actual Actual Actual Advance Prelim Yr/Yr
Real GDP 5.6% 2.6% 2.0% 2.5% 1.3% 0.7% 1.9%
PCE 4.8% 2.6% 2.8% 4.2% 3.8% 4.4% 3.5%
  Durables 19.8% -0.1% 6.4% 4.4% 7.3% 8.8% 4.8%
  Nondurables 5.9% 1.4% 1.5% 5.9% 2.9% 3.5% 3.1%
  Services 1.6% 3.7% 2.8% 3.4% 3.7% 4.0% 3.5%
Business Invst. 13.7% 4.4% 10.0% -3.1% 2.0% 2.9% 3.5%
  Structures 8.8% 20.3% 15.7% 0.9% 2.1% 5.0% 10.2%
  Equipment 15.6% -1.4% 7.7% -4.8% 1.9% 2.0% 0.8%
Housing -0.3% -11.1% -18.6% -19.8% -17.0% -15.4% -16.3%
Inventories($B)* $41.2 $53.7 $55.4 $22.4 $14.8 ($4.5) $29.9
  Farm $4.3 $1.9 $2.5 $2.4 $3.0 $2.6 $1.1
  Nonfarm $36.8 $52.2 $53.3 $20.0 $11.3 ($7.8) ($64.3)
Net Exports($B)** ($636.6) ($624.2) ($628.8) ($582.6) ($597.8) ($611.8) $24.8
  Exports 14.0% 6.2% 6.8% 10.6% -1.2% -0.6% 5.7%
  Imports 9.1% 1.4% 5.6% -2.6% 2.3% 5.7% 2.5%
Government 4.9% 0.8% 1.7% 3.4% 0.9% 1.0% 1.7%
  Real Final Sales 5.6% 2.1% 1.9% 3.7% 1.6% 1.6% 2.3%
For Yr/Yr: * average, 
For Yr/Yr: ** Change from Yr ago Qtr
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