INVESTMENT OUTLOOK: HOW TO GET AHEAD : LOOKING AHEAD : REAGAN’S GIFT TO BUSH MAY BE A TIME BOMB : Economists Worry That The Recovery is Ticking Away
When George Bush takes over the presidency, he is likely to inherit a U.S. economy that has been expanding for 74 months, the longest period of peacetime growth during this century.
Yet economists are wondering: Did Ronald Reagan bequeath his vice president a great gift or, rather, a defective piece of merchandise destined to break down with painful consequences for investors and everyone else?
Most experts believe that the post-Reagan era will dawn with continued prosperity for millions of Americans. Yet they worry that the unprecedented national debts piled up in the Reagan years--compounded by an aging recovery--ultimately could force a day of reckoning.
“The Reagan economic legacy isn’t all rosy,” says Harold C. Nathan, a vice president and senior financial economist at Wells Fargo Bank in San Francisco. “There’s a dark side to it, too.”
Many analysts still expect the economy to grow modestly next year. They are less confident about 1990 and beyond, however, pointing to a rogue’s gallery of potential problems:
- Debt levels--both in households and corporations--are disturbingly high and would prove particularly damaging in a recession. Bondholders in highly leveraged companies would share in the pain. The nation’s deficits in trade and federal spending, meanwhile, persist.
- After years of slumber, inflation showed signs of awakening in 1988. A result: Interest rates have edged up, further agitating investors.
- Manufacturing--the U.S. economy’s locomotive in 1988--is running out of room to grow as factories reach capacity. This raises doubts about further progress toward cutting the trade deficit.
It’s a confusing picture by any standard, one that poses hard questions for investors: Should they move conservatively into money market funds, or heed those bullish voices that claim the stock market is full of bargains? Has the time arrived for such classic inflation hedges as gold and real estate or are the fears over rising prices overblown?
“We have a more leveraged society in general--business, government and consumers,” warns Larry J. Kimbell, director of business forecasting at UCLA, adding: “It might be a time for investors to be a little more cautious.”
The next President’s role in wrestling with these dilemmas may prove limited, however. Unlike Reagan, who presided over a historic shift toward lower taxes and less regulation, Bush may act as a fine-tuner rather than a reformer.
“The Reagan years were times of great upheaval and change in economic policies, legislation and institutions,” writes Allen Sinai, chief economist with Boston Co. in New York. “The tide of history usually leaves to the next Administration the task of picking up the pieces and fine-tuning, not making any momentous changes from what has preceded.”
Even fine-tuning could prove a challenging task. If the economy does turn downward, for example, the $155-billion federal budget deficit severely limits the tools at the new President’s disposal--such as tax relief--to ease the pain.
In mid-November, Bush got a foreshadowing of the difficulties that await. Financial markets got so nervous over his view on the dollar’s appropriate value on foreign exchange markets, that Bush had to interrupt a Florida getaway to stress his commitment to current policy.
Clearly, there are real limits to how much Bush can steer the economy at first. The U.S. budget for next year already is in effect; the new President’s recommendations will be for federal spending starting in late 1989--at the earliest.
“A President can’t just do what he wants to do,” points out Michael Penzer, a senior economist at the Bank of America in San Francisco. “He’s got to get Congress to go along.”
Says Sinai: “No new President is likely to have a significant effect on the economy in the first year and even in the second year after an election. The economy is just too big--some $4 trillion in real terms--and requires at least a $40-billion shift in outlays to change real growth by one percentage point.”
Indeed, the realities of the business cycle are likely to shape events in 1989 far more than any new ideas emanating from the White House.
An uptick in inflation this year, for example, has been driven in part by tight labor markets, which are characteristic of a recovery in its latter days. In October, the Labor Department’s index of hourly earnings took its biggest leap in seven years. Similarly, many factories are running almost full time, raising the potential of future product shortages. Neither condition is likely to be reversed unless growth slows.
“The magnitude of the rise (in employment) during October leaves little doubt that labor markets are tight and pressure for higher wages is building,” warn economists at Daiwa Securities America in New York.
In another sign that the expansion is becoming a senior citizen, consumer spending growth no longer is soaring as it did a few years ago. And that suggests that many American households have completed a lot of their buying plans for the time being. Thus companies dependent on household purchases are in a slightly more uncertain position than those serving other businesses, a factor that could have implications for investors.
If the expansion is to continue, analysts agree, manufacturing and exports must play an important role in propelling it. On the positive side, government surveys have found that companies still plan investment increases next year.
Yet there are growing doubts about how much more can be expected of U.S. industry. In the third quarter of this year, business investment and exports seemed to sputter, although more recent data has been encouraging.
In the complex U.S. economic equation--where one variable inevitably affects others--a slowdown in business investment could mean bad news for the trade deficit. The trade gap shrunk this year because of strong export growth, but the limited capacity left in American factories means that “The big gains in improving the trade deficit are probably over,” maintains Wells Fargo’s Nathan.
What is more, a decline in the nation’s trade balance tends to push down the dollar. And downward pressure on the dollar, such as that seen recently, triggers upward pressure on interest rates, because the United States must continue to lure foreign investors to finance its debts.
Nathan, for example, describes the trade deficit as “this visible, ugly inheritance from the Reagan years which is likely to drag the dollar lower.”
Bush will get a different sort of inheritance from Reagan in the form of a Federal Reserve Board that appears committed to fighting inflation and protecting the dollar, even at the cost of restraining U.S. economic growth.
Thus, some analysts see possible tension between Bush, who will want to keep the expansion on track, and a Fed with its own set of priorities. “You could have a much more activist Federal Reserve in the next four years than you had in the last four years,” said Norman E. Mains, chief economist at the Bateman Eichler, Hill Richards investment firm in Los Angeles.
The new President also may find a restive Congress, strengthened in its Democratic majority and unwilling to concede him a mandate in light of the relatively close popular vote. Some observers argue that--despite the limits on a new President--Bush must figure a way to put his imprint on U.S. spending policies swiftly, or risk the consequences.
“If the new Administration does not show quick and decisive leadership on the deficit, there could be another sharp downward correction of the dollar,” predict economists at the WEFA Group, a consulting firm in Bala-Cynwyd, Pa. “This would be accompanied by sharply higher inflation and interest rates. The net result of these events would likely be a recession in the United States.”
Does that sound like a lot to worry about? Don’t forget the imponderables of war, drought and crisis--political and financial--that nobody can foresee. But if the post-Reagan economy seems clouded by potential troubles, it’s worth remembering that many experts were a lot gloomier at the end of 1987 than they are today.
Just a year ago, the experts worried that the October, 1987, stock market crash would drag the United States into a recession. But the economy proved too resilient, proving the doom sayers wrong.
“If the economy can shake off that one, I’m not sure what can push it into a recession,” said Mains.
THE OUTLOOK FOR NEXT YEAR In late October, a survey of 51 economists resulted in a forecast of slower GNP growth, faster inflation, higher short-term Treasury bill rates and no change in unemployment. Source: Blue Chip Economic Indicators of Sedona, Ariz.
