Bust to Boom? Signals From Economy Hint at V-Like Rebound
The U.S. economy stunned the experts--including the Federal Reserve--with how quickly it plunged to an apparent near-zero growth rate in recent months.
Could the next surprise be how rapidly the economy recovers from that plunge?
The potential for a “V-shaped” recovery--a fast rebound from a sudden dive--is a matter of great debate on Wall Street, in part because the stock market’s surge in January appeared to be a big bet on exactly that kind of comeback.
On Friday, more evidence suggested that the overall economy wasn’t, in fact, in as dire a situation last month as has been widely depicted. The government estimated that businesses created a net 268,000 new jobs in January, despite more job losses in manufacturing.
The stock market, ironically, had trouble with Friday’s report, as investors’ first reaction was that the Fed now might think twice about another interest-rate cut. The central bank Wednesday made the second half-point cut in its key short-term rate in a month, after declaring that the economy’s weakness “called for a rapid and forceful response of monetary policy.”
The Nasdaq composite stock index slumped 4.4% on Friday, cutting its year-to-date gain to 7.7%, and the Standard & Poor’s 500 index lost 1.8%, leaving it up 2.2% for the year.
Still, Friday’s market decline was on modest trading volume, indicating no mad rush for the exits. And if the economy is indeed a lot further from recession than feared, that should ultimately be positive for corporate earnings and, quite likely, for many stocks.
The Fed’s dramatic rate cuts in January weren’t based on mere conjecture about the U.S. economy, of course. A raft of data since November pointed to a sharp slowdown in consumer and business spending. Robert McTeer, head of the Fed’s Dallas bank, aptly described the situation Friday when he said the economy appeared to hit an “air pocket” in November and December.
The Fed’s concern is that the laws of gravity tend to apply in the economy and financial markets: It is easier to fall off a cliff, and keep falling, than it is to climb back up.
But analysts also note that the U.S. economy’s growth rate has ebbed many times throughout the overall powerful expansion of the last decade. In the second quarter of 1995, for example, real growth in gross domestic product was just 0.8%. The growth rate rebounded quickly to 3.1% in the third quarter of that year and 3.2% in the fourth quarter.
The government now estimates that real GDP rose a mere 1.4% in the fourth quarter of 2000, decelerating from a 5.6% rate in the second quarter.
But couldn’t the fourth-quarter slowdown give way to a strong rebound by spring or summer, rather than to the drawn-out malaise that some analysts fear?
One of the key indicators that appears to have spooked the Fed is the steep drop in consumer confidence in recent months. Last week, the Conference Board said its January survey of consumer confidence showed the steepest dive in more than 10 years.
But many economists question the value of confidence readings in forecasting future consumer spending--which is, after all, the economy’s principal driving force.
Gordon Richards, economist at the National Assn. of Manufacturers in Washington, argues that consumer confidence measures tell you more about about peoples’ recent spending patterns than about what they’re actually likely to do in the months ahead. “It’s a lagging indicator,” he says.
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What’s more, how people said they felt in recent months hasn’t translated into the type of drastic spending slowdown that might be expected.
New home sales, for example, were at a seasonally adjusted annual rate of 975,000 units in December, the highest since November 1998.
January car sales, reported Thursday by major auto makers, were down 6.2% from a year earlier, but that was less of a drop than many analysts had expected.
Although spending on goods was weak in the fourth quarter, spending on services rose at a 5.3% annualized rate, up from 3.7% in the third quarter, the government’s GDP report showed.
With the economy still creating net new jobs in January--and the Fed having lowered short-term interest rates a full percentage point already--a collapse of consumer spending any time soon is “implausible,” Richards argues.
Lower mortgage rates have meant a boom in mortgage refinancings, which will put more money in many consumers’ pockets each month. Housing values also are key to the consumer spending outlook, many analysts note: Ongoing strength in the real estate market means the largest asset many Americans own--their home--is holding its value, or even rising further.
Finally, President Bush has made clear he is serious about a deep federal income tax cut, which might well be made retroactive to Jan. 1. If consumers begin to factor that into their financial equation for the year, it could become a confidence builder for the economy sooner rather than later.
“From the look of things in Washington, it would be surprising if taxes were not cut by at least enough to provide a palpable boost to the economy,” said Scott Grannis, economist at Western Asset Management in Pasadena.
Though consumers may be in better shape than confidence surveys and other indicators might suggest, analysts are less sanguine about the outlook for business spending--a smaller portion of total GDP growth, but hardly insignificant.
Business investment dropped at a 1.5% annual rate in the fourth quarter, the largest decline in nine years, according to Edward Yardeni, economist at Deutsche Banc Alex. Brown.
Spending on technology rose at a 9.6% annual rate, but that was still the weakest gain since 1994, Merrill Lynch & Co. data show. In other words, the crash in most technology stocks in the fourth quarter stemmed not from a simple change in investor psychology, but from a genuine change in the fundamentals.
Analysts who argue that the economy cannot stage a V-shaped recovery in part base their forecast for sustained weakness on the idea that companies over-invested in technology and other equipment in recent years, and that such spending now will grind to a halt--in turn depressing business across the all-important technology sector.
Business inventories nationwide continued to rise in the fourth quarter, even as sales waned. “Inventory-building remained excessive in all [business] sectors,” said Bruce Steinberg, economist at Merrill Lynch.
But he expects the inventory correction to run its course by mid-year. By contrast, economist Stephen Roach at Morgan Stanley Dean Witter in New York takes a much dimmer view--not just of the inventory picture, but of the chances for a significant rebound in the economy this year.
Asked about talk of a V-shaped recovery, Roach scoffs: “Anything is possible. But that is the residue of optimism that is embedded in securities markets.”
Economies, Roach said, suffer severe and elongated recessions after “excesses” of spending and investment have built up for extended periods. “And this has been a period where excesses rose to a level that has not yet been appreciated,” he argues, referring to the 1990s’ boom in general and to spending on computers and other technology in particular.
Similarly, Paul Kasriel, economist at Northern Trust in Chicago, believes that the level of debt taken on by consumers and businesses in the 1990s is likely to prove to be a depressant on the economy for some time--just as debt levels helped hold back the recovery in the early-1990s.
Yet Kasriel concedes that worries about debt levels have been constant for the last few years, even as the economy has continued to boom. With interest rates coming down, and the job market still generally strong, why should debt issues now come home to roost with consumers?
Kasriel agrees that, if the Fed continues to lower rates and pump up the credit available in the economy, American consumers may well respond as they have historically: “If you print it, they will spend it,” he said.
If a V-shaped recovery is indeed in the offing, does the stock bull market resume as well? That is a trickier call, many analysts say. An economic rebound that lifts depressed corporate earnings should underpin stock prices.
But the problem may be in the bond market: If bond investors begin to smell a true recovery, bond yields may snap back in a hurry--quickly halting any Fed plans for deeper interest rate cuts, and raising the potential for new Fed rate increases.
Hence, Kasriel argues that people who hope for a V-shaped recovery may regret it if one in fact arrives. “If it happens, it will be short-lived,” he contends.
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Tom Petruno can be reached at tom.petruno@latimes.com.
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Consumer Credit: Bane or Balm?
Some analysts who worry that the economy could sink into recession this year say high levels of consumer debt could mean spending will be curtailed if people pay off loans. Other analysts, however, say a rebound in confidence could boost Americans’ willingness to take on more debt, fueling a new round of spending.
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Consumer debt outstanding, in billions, end of each year (excluding mortgage debt)
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2000: $1,523 billion
2000 year-end data is through November (latest figure available). Consumer credit includes consumer loans and credit card debt, but excludes home mortgages.
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Source: Commerce Department
Ebb and Flow
Quarter to quarter, the U.S. economy’s pace can vary widely. Amid the overall strong economic expansion of the last six years, quarterly growth has ranged as low as 0.8% and as high as 8.3%. Here’s a look at real (after-inflation) growth in gross domestic product each quarter since 1995.
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Percentage change in real GDP each quarter
Source: Commerce Department
