*Extra* Daily Interview: Parsing the GDP Data

A 2% GDP growth rate for the first quarter is excellent news, says Steve Slifer, co-chief U.S. economist at Lehman Brothers. It indicates that inventories are being aggressively worked through, yet it isn't strong enough that it will prevent the Federal Reserve from cutting interest rates further, Slifer says.

Heartened by aggressive Federal Reserve rate cuts, the strong possibility of a tax cut and consumer spending, Slifer predicts that inventories could continue to be worked through in the second quarter, with the GDP growth rate coming in between 1% and 1.5%. But by the second half of the year, Slifer says the economy will be back on track with a GDP growth rate of 3% in the third quarter and 4% in the fourth.

And if April 4 really was the bottom of the market, as Slifer thinks it may have been, the S&P 500 should return 30% over the next 12 months.

TSC: What does the stronger-than-expected GDP figure mean for the market and for the economy?

Slifer: It's certainly a far stronger number than what people had expected.

The composition of growth was even stronger than what the 2% growth rate would imply. The only reason we ended up as weak as we did was because of this huge drop in inventories. If you strip those out and look at final sales figures, sales were up a whopping 4.6% for the quarter. That's huge, absolutely huge. What happened was that inventories subtracted 2.6% from that, and you ended up at the 2% mark.

Now this inventory-reduction process has about run its course, so we are thinking of raising our second-quarter [GDP] growth rate from 0.5% to a range of 1% to 1.5%.

That's about it. By the time you get to Q3 and Q4, we're on the road back to faster stuff, with growth of 3% in Q3 and 4% in Q4.

Steve Slifer Co-Chief U.S. Economist Lehman Brothers,

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TSC: Could the higher-than-expected GDP figure deter the Fed from cutting rates further?

Slifer: It's obviously a strong number, so on the one hand, you might think that the Fed might become less aggressive. That's possible. We have been looking for a 25 [basis-point cut] in May and another 25 [basis-point cut] in June. The consensus had been for 50 in May. I think they'll probably want to rethink that a little bit. For our part, we're probably still happy with our rate call.

But because of this easing bias, I expect we'll get something in May. It's more likely to be 25 than 50. You could pull the plug on that final rate cut at the end of June, but it will depend on the flow of data. If we wind up with 1%, 1.5% GDP growth in Q2, I expect we'll get it. But if things look a little stronger than that, GDP growth closer to 2%, then that might disappear as well.

TSC: Do you think the market has reached a bottom?

Slifer: The stock market is looking increasingly like it established the low on April 4, and what [Jeff] Applegate, [chief investment strategist at Lehman,] reports is that once the stock market has established a bottom, you look forward 12 months and the S&P is typically up 30%. But of that gain, half of it, or in this case 15%, happens in the first 60 days. Well, in fact, as we speak here, we are up 13%. So it seems we are on that fast recovery growth for GDP.

As the stock market continues to start climbing here, I think that will boost both consumer and business confidence.

TSC: Why do you think consumer spending has continued to be so strong?

Slifer: The slowdown has been confined to the manufacturing sector. Services and housing have been largely unaffected. So, once things begin to turn -- think of it, you've got all these manufacturing guys with just-in-time inventories -- so once it begins to turn, my guess is that it will begin to turn fairly rapidly.

We might have a couple more months of this sluggishness, but I think the end of the road is in sight.

TSC: Why have you continued to be so positive about the economy?

Slifer: Number one, the Fed. They've been [cutting rates] since Jan. 3. If it takes six to nine months for that to kick in, growth should begin to kick in during the third quarter, with some of the more recent cuts goosing growth in the fourth.

Second, people don't talk about this, but fiscal policy. Hang on, the Senate just passed up to $85 billion of tax cuts for this fiscal year, 2001, the one that ends Sept. 30. While the House doesn't agree, they are going to get together. You're not going to get no tax cuts, but perhaps something in the middle. Pick a number: $50 billion, maybe. If this thing passes in June or in July, the IRS is going to start mailing out checks to us in August. If you put 50 billion bucks in consumers' pockets, the next question is, how much will consumers spend? Let's assume they spend only half of that. That alone would add a percentage point to GDP.

Third, once you get to October, they are going to start lowering the withholdings to get to the tax cuts they were talking about for fiscal 2002.

Lastly, we've been focusing on the last year when the stock market's gotten whacked. That's true. But from 1995 to 1999, this thing was going up 20% every year. Those capital gains aren't counted in any income measure, but those were real gains, and some people took their profits and spent it. I don't get the sense that the consumer is in nearly the dire shape that the numbers would suggest.