Just-Right GDP Slays Bears

Buyers flock back in after a tame revision to quarterly growth.
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Stocks got their groove back Thursday, as an expected upward revision of first-quarter growth and tame price data let traders squeeze in more gains two days ahead of a long holiday weekend.

Technology issues, after being battered early this year, continued to lead the rally. The

Nasdaq Composite

gained 21.12 points, or 1.03%, to 2071.24. This time the Internet sector took the lead after news that

Yahoo!

(YHOO)

plans a new online photo service.

The

Dow Jones Industrial Average

finished up 79.80 points, or 0.76%, at 10,537.60. The blue-chip average was boosted by the likes of

Boeing

(BA) - Get Report

, which won a $3.9 billion order from Indonesia's Lion Mentari Airlines, and by

AIG

(AIG) - Get Report

. The battered insurance group was slapped with a lawsuit by New York Attorney General Eliot Spitzer, but the market's betting this will clear the air.

The

S&P 500

, meanwhile, slightly trailed the other indices, gaining 7.61 points, or 0.64%, to 1197.62. The index was held back by shares of retailer

Dollar General

(DG) - Get Report

, which fell more than 11% after its earnings missed analysts estimates. Mixed results from

Costco

(COST) - Get Report

and lower guidance from

Heinz

(HNZ)

also weighed.

But energy shares continued this week's uptrend, in sync with the sustained rebound in crude oil prices. Crude for July delivery finished up 3 cents to $51.01 a barrel on Nymex.

Breadth was positive, with advancing issues outpacing decliners by more than 2 to 1 on both the

New York Stock Exchange

, where 1.3 billion shares changed hands, and the Nasdaq, where 1.6 billion shares traded.

Virtually every sector of the market was lifted after the upwardly revised growth estimates, but the housing sector shone particularly bright. Another blowout quarter from homebuilder

Toll Brothers

(TOL) - Get Report

reminded investors who's been driving economic growth over the past few years. The Philadelphia housing sector index gained 2.68%.

And the housing sector still seems to have some bright days ahead as the yield of the benchmark 10-year Treasury, which is used to set mortgage rates, hovers slightly above 4%. On Thursday, the 10-year note rose 1/32, while its yield fell to 4.08%.

According to the latest estimate, the GDP rose at 3.5% in the first quarter instead of the 3.1% previously estimated by the Commerce Department. Economists on average expected first-quarter growth to be revised to 3.6%. In spite of the bullish signal for growth, Thursday's number didn't contain worrisome inflationary pressures. The GDP's core personal expenditure price index, a key inflation gauge closely watched by the Fed, remained unchanged at 2.2%.

Undoubtedly, the revised GDP -- together with strong April employment and retails sales -- confirmed in investors' minds that the stagflation fears of the past few months were overblown. In the meantime, the "wall of worry" built by those previous fears, and by recent credit jitters in the hedge fund world, is holding steady. And, fundamentally, profits are still strong.

Another report Thursday showed that pretax corporate profits soared 23.6% to $1.307 trillion in the first quarter. Year-on-year growth of 35.9% was the fastest since 1987.

Yet, there's trouble ahead if the market persists in discounting inflationary pressures more than the

Federal Reserve

does. There are increasing expectations in the market that, amid little evidence of inflationary pressures, the Fed may halt its tightening campaign sooner rather than later. But Fed officials have made it abundantly clear over the past couple of days that it has every intention to return monetary policy to a neutral stance.

Where are inflationary pressures coming from? After all, crude oil prices (besides this week's action) have been steadily declining since April. Other commodity prices also have declined. Employment growth, although not as bad as the March report led to believe, has remained tepid.

Perhaps another part of the GDP report, which received little attention Thursday, can offer some explanation. The Commerce Department also revised upwards its estimates of employee compensation by 2 percentage points for both the fourth quarter of last year and for the first quarter of this year.

Economists can only speculate as to where the revisions came from, as the government does not break down the report into its components. But according to Lehman Brothers economist Joseph Abate, the bulk of the revisions came as the government received more data on bonus pay and the value of stock options from tax and corporate filings.

"Higher than assumed growth in bonuses and exercised stock options might explain a number of things including ... strong consumer spending in the face of higher gasoline prices," Abate says. "And it certainly wouldn't be inconsistent with the good year enjoyed by Wall Street and real estate markets in 2004."

In the meantime, consumer sentiment has been hit, as shown in April consumer sentiment surveys (the market will get a May update on sentiment from the University of Michigan on Friday) and industrial activity has weakened.

So while consumption, employment and wages have trailed behind, asset-based inflation is catching up to the Fed's easy-money policy of the past few years. For the Fed, this will likely trump indications provided by the tame April consumer price index.

"Even if CPI inflation were to moderate into the 2% to 2.5% range year on year, a 4% to 5% fed funds rate target would be appropriate to get policy back into a neutral stance," says Wells Fargo senior economist Scott Anderson.

To view Aaron Task's video take on today's market, click here

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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