In Weak GDP Report, Bulls See Reasons for Optimism

Stocks rallied sharply into Wednesday's FOMC announcement despite a much weaker-than-expected report on first-quarter GDP...or maybe because of it. The 6.1% decline was far worse than forecasts, but bulls took heart that a big chunk of the decline stemmed from a record $103.7 billion drop in business inventories. With inventories so lean, the hope is that businesses will have to start running production at or near full capacity once the recovery gets underway, or risk being out of stock and losing potential sales.

Meanwhile, consumer spending rose 2.2%, boosted by big gains in purchase of durable goods. Finally, state and local government spending fell 3.9%, the largest decline since 1981 -- but nobody expects that trend to last. "With the ‘spend-out' from the fiscal stimulus likely to kick into gear beginning in the second half of 2009, and with demand stabilizing, government spending and inventory restocking should be accretive to growth during the second half of the year," writes Michael T. Darda, chief economist at MKM Partners.

The market is also rallying because the end of the month is coming, which is forcing those short or "under-invested" to scramble and get long (or at least flat). But on a more fundamental basis, the market's recent rally is pricing in a more robust second-half recovery than today's GDP report suggests is likely, certainly not from the headline figures.

"Although the economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time," the FOMC said in its policy statement.