GDP Data Show Surge in Corporate Profits

Bonds believe current growth will lead to Fed rate cuts.
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The economy grew faster than expected in the third quarter, increasing at anannualized pace of 2.2% instead of the 1.6% reported in the government'sadvance estimate. The consensus was for a revised gain of 1.8%. The dataare unlikely to alter the way investors perceive the currenteconomic situation, particularly because the data are backward looking.

Nevertheless, with GDP growing below 3% for a second consecutive quarter andlikely to do so for a third straight quarter here, thebond market will continue to view the current growth path as one that willultimately lead to the

Federal Reserve

lowering interest rates.

Inventory Buildup and Spending

Two-tenths of the 0.6% upward revision to third-quarter GDP was due to an upwardrevision to inventory investment. Recent data indicate that inventorieshave increased at a faster pace than normal, suggesting there has recentlybeen an unintended buildup of business inventories.

The buildup isimpacting current production, with businesses cutting back on orders andproduction in order to bring their inventories back to desirable levels.The inventory buildup is small, so the adjustment process should be short.

Business spending was revised upward to show a 7.2% rate of gain instead ofthe 6.4% rate reported in the advance estimate. The gain is tainted by Tuesday's report on durable goods orders, which indicated that businessspending may have begun the current quarter on a weak note.

Commercial construction spending was also revised upward, with the thirdquarter now showing an annualized gain of 16.7% instead of 14.0%. The gainfollows a 20.3% gain in the second quarter, making the two-quarter gain themost since at least 1990. In dollars, commercial construction spendingincreased at an annualized pace of about $11 billion, offsetting about athird of the decrease related to residential construction spending.

Consumer spending was revised downward to show a 2.9% rate of gain insteadof 3.1%. More of the spending that did occur, however, was spent onservices, with the figure on personal spending on services revised upward toshow a 3.1% rate of gain instead of 2.8%.

Goods vs. Services

In other words, people weren'tbuying stuff, they were buying services. This is actually good news on thejobs front, as over 80% of U.S. jobs are service-related.

While better forthe job market, the data are bad news for sellers of goods (retailers, forexample) and factories. Importantly, with factory-related economic datadominating the economic calendar, perceptions about the economy will tilttoward the negative if the sluggish pace of spending results in weakerfactory activity, as is normally the case.

Interesting and surprising was the government's downward revision of $100.3billion to wages and salaries. The figures reflect new salary tabulationsobtained from the Bureau of Labor Statistics, according to Market News. Thefigures will result in a downward revision to the 5.3% gain reported forunit labor costs during the quarter, probably in the vicinity of about 4% ora bit lower. This means that more of the income generated during thequarter went to businesses -- corporate profits.

To be specific, thegovernment's data on profits after taxes and adjustments for capitalconsumption and inventory valuation show an increase of 31.5% from a yearago.

Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of

The Strategic Bond Investor

. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback;

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