Expansion Picking Up Speed

Updated from 8:46 a.m. EDT

The U.S. economy expanded at a 5.8% clip in the first quarter, the Commerce Department said. But the GDP number, which came in better than economists expected, exaggerates underlying strength.

At the same time, the University of Michigan's consumer sentiment index fell more than forecast to 93 in April from 95.7 in March, amid concerns over geopolitical events and rising oil prices.

In late-morning trading, investors took little solace from the strength in the GDP report, and instead focused on the dip in confidence and lingering worries about corporate profitability. The

Dow Jones Industrial Average

was off 41.8 points at 9,993.41, while the

Nasdaq

was lower 17 points at 1,696.5

Economists said that a number of temporary factors were responsible for the strong GDP report.

John Lonski, an economist at Moody's, said: "If the GDP is so great, how is it that corporate profits are so punk and there are five times as many credit downgrades as upgrades?"

The GDP drew most of its strength, or 3.1 percentage points of the gain, from a rise in inventory investment. In the first quarter, business reduced stockpiles at a $36.2 billion annual pace after cutting a record $119.3 billion in the prior quarter. The big swing in inventory investment, economists said, is transitional.

"We've come a long way toward balanced production," said Ethan Harris, an economist at Lehman Brothers. "But this was the biggest closing of the inventory gap. From here, it will be more incremental."

Another potentially temporary element of strength in the GDP report was a 15.7% gain for new housing spending. "The housing market won't collapse," said Harris. "But construction will be flat to down in the second quarter, and we've already seen signs of that in the latest housing starts report."

Real final sales, which exclude inventories, rose at an annual 2.6% rate, down from a 3.8% increase in the prior three months, and a sign that the economy is not yet in full recovery mode.

Still, the expansion in gross domestic product was the fastest since the final quarter of 1999, and it provides evidence that the recession that began in early 2001 has ended. The first-quarter gain follows a 1.7% expansion in the fourth quarter of 2002. Economists expect moderate growth in the current quarter.

According to Blue Chip Indicators, the consensus is for a 3.4% expansion over the rest of 2002.

In many ways, the recovery hinges on business investment spending, which fell 5.7% in the first quarter after dropping 13.8% in the fourth quarter. That helps explain why profitability is still weak.

"The quarter-over-quarter decline was not as severe as it was in the fourth quarter," Lonski said. "But you still can't conclude, with any confidence, that business spending is coming back."