(FORTUNE Magazine) – If there's one thing the economy is producing lots of lately, it's bad news. Factory employment has dropped in nearly every month this year, pushing the total of manufacturing jobs down by 136,000 through July. Housing starts are their lowest since 1982. Businesses have been reporting weak profits all year. The Commerce Department's latest GNP figures showed second-quarter growth slow enough to raise recession fears. But take a closer look: There's still plenty of life left in the nearly eight-year-old expansion. FORTUNE has shaded its 1990 GNP growth forecast to 1.5% from 1.8%, partly in response to the Commerce Department's downward revision of final demand for 1989, which showed that the economy entered 1990 weaker than expected. But we are leaving our 1991 forecast unchanged at 1.5%. Doddering a bit, the expansion will continue. Honest. Not even a $5-a-barrel oil price run-up caused by the latest Mideast strife should knock the economy off track. If that increase is sustained, it would add no more than half a percentage point to inflation this year. The underlying health of manufacturing gives cause for tempered optimism. From December to June, manufacturing output rose 1.7%, or at a respectable 3.5% annual pace (see chart). And the industrial employment figures for July are not as weak as they appear at first glance. Though total manufacturing jobs for the month were down by 7,000, all of the reductions came through cuts in white-collar overhead. Employers added 7,000 production workers to their payrolls, hinting that demand is firm. Rising output in the chemical industry is an important signal that manufacturing's strength runs deep. U.S. companies are lifting production of inorganic chemicals, the fundamental building blocks used in a host of industrial processes. They also increased output of plastics resins by 7.6% in May from a year earlier, pushing year-to-date production up 3.3%. Given the sorry state of the construction industry, a key market for plastics, it's clear as Lucite that chemicals won't have a banner year. Still, demand for packaging material, the single most important market for resins, is firming. Richard Stuckey, chief economist of Du Pont, also cites pickups in demand for engineering polymers, used in the manufacture of a broad range of products from taillights on cars to valves for aerosol cans. He attributes the improvements to exports and inventory building by customers, whose stocks he describes as lean. Following a sharp deterioration in the second half of 1989, he says, ''we have seen the tone of our markets improve very broadly.''

The biggest worry is whether manufacturing's rising output will flow through to final demand or continue piling up in warehouses. The Commerce Department's estimate of second-quarter real GNP showed the economy growing at just a 1.2% annual rate, but without inventory accumulation total output would have declined. While the bulge in stocks will be a drag on production for the rest of the year -- particularly in the third quarter -- it will not lead companies to slash orders and production as they sweat off the excess (see chart, page 24). This is the picture that emerges from FORTUNE's quarterly survey of 175 producers, wholesalers, and retailers. The respondents said they would like to cut inventories relative to sales by about 3%, twice as much as they wanted to trim in the first quarter. At the same time, they continue to expect modest , economic growth. They look for their own companies' sales to expand strongly enough to accommodate some additional inventory increase, albeit at a considerably slower pace. But will final demand pick up? During the second quarter every component of private spending -- consumer outlays, business investment, homebuilding, and exports -- fell. There were aberrations aplenty in the numbers, however, and FORTUNE expects final sales of goods and services to rebound sufficiently to keep growth on track. Weaker than expected commercial aircraft sales, for example, explain part of the big slowdown in capital spending. But airframe manufacturers' books are bulging with backlogged orders, pointing to a recovery during the year's second half and beyond. Sales in the computer industry should also recover from their stumble in the June quarter. Buyers have been holding back as they wait for new products, such as a mainframe IBM is expected to launch in 1991. In general, capital goods manufacturers can take heart from the Commerce Department's upward revision of first-quarter profits. Though earnings were still lower than the year before, the revision indicates that companies are better able to afford to buy more equipment. They cannot afford not to. Strong global competitive pressures should continue to spur new investment. The second-quarter drop in U.S. merchandise exports, the engine that has powered the economy in recent years, is another temporary setback that resulted in a large deterioration in the trade deficit. FORTUNE expects a resumption of stronger export sales because the economies of America's trading partners are growing briskly. The optimism is borne out by the experience of Parker Hannifin, an industrial components manufacturer based in Cleveland. The company's revenues from exports are up 10% to 15% this year, in part reflecting especially strong demand from South Korea for its air conditioner and construction equipment parts. Says Paul Schloemer, president and CEO: ''We expect exports will remain strong because overseas markets are strong.'' Any lift the consumer gives the economy will be modest -- but significant. Household spending accounts for about two-thirds of GNP. With some state and local tax hikes starting to bite and federal tax increases looming, disposable income will grow slowly in 1990 and 1991. And the second-quarter household savings rate was already at a low 5.1%. How much deeper can consumers dig into their paychecks? Before adjusting for inflation, spending grew a hefty 1% in June, though income rose just 0.4%. The jump demonstrates that consumers aren't ready to cut living standards yet. But FORTUNE doesn't expect the savings rate to fall much, and we predict that real consumption will grow at a below-average 1.8% yearly rate through 1991. As with the rest of the economy, consumer markets are spotty. Sales of furniture and appliances are starting to get hit by the slowdown in home sales. Women's clothing, coming off a strong year in 1989, is suffering from a lack of exciting styles. But other areas, such as toys and men's clothing, are doing better. Domestic autos are picking up speed. Unit sales in July were running at a 7.1 million annual rate, vs. April's depressed 6.6 million level. Sales were still 2% below a year ago, so the industry is hardly thriving. But the worst appears to be over. Reason: Drivers will begin replacing the older models they bought in large numbers in the mid-1980s. By almost any measure, real estate is in recession. So far this year, sales of new and existing homes are down 10% and 2%, respectively, from a year ago, and house prices are barely keeping up with inflation. But what's bad news for sellers is good for buyers. The average family is in better financial shape to purchase now than it was a year ago, according to the National Association of Realtors' affordability index, and recent sales figures are beginning to reflect that buying power. New-home purchases jumped 8% in June to their highest since February, and existing-home sales registered their first increase in seven months. FORTUNE expects new single-family housing starts to rise by about 100,000 units from their depressed second-quarter level to a one million annual rate by the end of 1991. ''Recession'' remains a perfectly useful word that lexicographers and economists shouldn't strike from their dictionaries. But don't expect it to spring from the dictionary to the history books when the overall economic travails of 1990 and 1991 are described in the future.

BOX: OVERVIEW

--Investment, exports, and consumption will rebound. --The inventory jump will lead to slower stock building but not to a slash in output. -- While housing remains in recession, the worst is over.

FORTUNE'S BASIC OUTLOOK

-- Growth: Real GNP will expand 1.5% during both 1990 and 1991. -- Inflation: GNP price increases will climb from 4% during 1989 to 5.5% in 1991. -- Interest rates: Next year they will be up a percentage point from the spring lows.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: Manufacturing production UPWARD BOUND Manufacturers will keep production rising after a temporary pause to slow inventory building. Growing demand for basic materials, like these Du Pont resins, is supporting overall factory output now.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: Change in nonfarm inventories STOCK CLEARANCE The second-quarter inventory surge hangs ominously over the economy. But final demand will be strong enough to allow producers to reduce stock accumulation gradually.