The View From Wall Street Is a Bit Distorted

Main Street thrives while Wall Street fidgets. That’s an accurate description of the financial world these days, as the latest reports show a solidly growing economy with little threat of inflation.

Yet the stock market seems confused. Stock prices have been gyrating furiously because investors can’t decide if the economy is getting stronger, a prospect that would lead to higher inflation, or weaker, which would result in lower corporate profits.

Business across the country shows no such bewilderment. The economic expansion that began in 1991 continues. Jobs are plentiful; unemployment is at 4.5% in the Midwest and 3.5% in parts of the Southeast, with the national average at 5.3%.

And paychecks, often swollen by overtime pay, are pretty good. The Labor Department reported Tuesday that Americans’ average weekly earnings rose in June at the fastest pace in 14 years.

Profits are mixed but strong, with a broad range of major corporations reporting higher quarterly earnings and some technology companies showing lower earnings.

The outlook is for further strength. The White House Tuesday raised its forecast for economic growth in the second half of 1996 to 2.6%, up from an earlier estimate of 2.2%. Growth in the April-June quarter probably ran at 4% or better, meaning that the immense U.S. economy turned out an additional $300 billion in goods and services.

That kind of output pays a lot of salaries, buys a lot of groceries.

So the question arises, what’s eating the stock market? Investors are viewing the economy in traditional terms, fearing that after five years of expansion, inflation and other problems should be growing. At this point, according to the traditional view, companies are having to pay higher wages to employees and charge higher prices to customers.

But the world has changed in ways that investors have yet to grasp. Technology and an enlarged global market have radically transformed the environment of U.S. industry, making things a lot better than they appear.

To be sure, wages nationally have begun to rise a little faster than inflation. Technology industries as well as those in boom areas have to pay premiums to attract skilled employees.

For many technology companies, the upward pressure on wages coincides with competitive pressure to cut prices. That in turn leads to shrunken profits and a tremendous crash of technology stocks. The technology-heavy Nasdaq market is off nearly 20% from its peak, and many individual issues are off 50% and more. The Nasdaq debacle has been the equivalent of a 1,000-point decline in the Dow Jones industrial average, spooking investors in all markets.

Yet lower profits for some computer, semiconductor and telecommunications producers is good news for major industrial firms, allowing them to buy computers and other equipment cheaper. Accordingly, such major outfits as General Motors, Rockwell International, Honeywell and Caterpillar reported higher earnings Tuesday.

The economy is “just not the same equation anymore,” says economist Diane Swonk of the First Chicago-NBD banking company.

The new “equation” takes into account the enlarged global economy, forever transformed by the emergence of East Asia with its billions of people. That region now buys more from U.S. suppliers and sells more to U.S. customers than any other.

And, along with traditional trading partners in Europe and Latin America, Asia provides competitors. U.S., and Japanese, technology firms have learned that South Korea, Taiwan, Singapore, India, Malaysia and other newly developing countries can turn out high-quality computer parts and software. Markets grow larger and more intensely competitive at the same time.

More important is the technology-assisted transformation in U.S. business in recent years that has been variously called “re-engineering” and “downsizing.” The reality is more complex. U.S. companies routinely cut costs by using computers to control production and inventories.

Now, thanks to computer networks, employees work independently, without bothering to rent “branch” offices. And companies form what amounts to partnerships with suppliers. An example is that oil companies seldom have large engineering staffs anymore, relying instead on professional firms, such as Fluor, Bechtel and Parsons for engineering services around the world.

The engineering firms, in turn, link their global operations by sophisticated information systems, calling in brainpower from several continents to solve a problem in any location. Technology, in short, gives U.S. firms increased productivity--more bang for the buck.

The example is pertinent to today’s confused stock market because all those software innovations don’t count as productivity gains in government statistics. The changed economy is incorrectly measured by traditional yardsticks and so looks vulnerable to limits on factory production, inflation and collapse from exhaustion.

But in reality, costs are being controlled and corporations are generating fresh capital to finance further growth.

“Part of the problem we’re having today is that our statistics are letting us down,” says economist Paul Krugman of Stanford University. “The economy is changing rapidly, but we don’t have very good information.”

That historical misunderstanding, which will be corrected in time, accounts for a lot of the confusion and anxiety about corporate earnings and inflation. Things often are better than they seem.

But nothing is perfect. After five years of expansion, some strains in the economy are inevitable.

U.S. business investment in computers, which has been running at almost $70 billion a year, is slowing this year. Sales of personal computers are up 20%, but that’s a slowdown from last year’s 40% growth. And earnings-reducing price wars have broken out in technology.

On the potentially inflationary side, there is a lot of corporate cash available in the economy and a rapid pace of business activity in some areas. “Unemployment in parts of Florida and Georgia is very low, and labor costs are likely to go up,” reports economist Lynn Reaser of Barnett Banks in Jacksonville, Fla.

A steep decline in the stock market would add a serious strain, reducing wealth for mutual-fund holders and making companies and lenders cautious.

In that sense, the $7-trillion-a-year colossus of the U.S. economy is like an ocean liner--formidable and powerful but needing to be kept at an even speed to be most effective.

That is why professional investors actually would welcome a small hike in interest rates as evidence that the Federal Reserve is on guard against inflation. “If [Fed Chairman Alan] Greenspan raises rates, I’ll bet you bonds will rally,” says Marc Kelly, a partner in Spectrum Asset Management, a Newport Beach investment firm.

Such a bond rally would lead to lower interest rates on mortgages and most business loans: good news for Main Street and Wall Street.