CROSS YOUR FINGERS, KNOCK WOOD: THAT MAY BE A RECOVERY OUT THERE
The flurry of upbeat data in January and February contains hopeful signs that faster growth lies ahead. It shows that consumers aren't acting as depressed as they say they feel, housing is responding to lower financing costs, car sales are a little stronger, and the industrial sector appears to be regaining some of the momentum it had lost.
But these signs are far from conclusive. Growth in the current quarter is shaping up to be a carbon copy of the fourth quarter's lackluster performance, and the crucial supports to a quickening of business activity--faster growth in employment and household incomes--have not yet fallen into place. Slowly but surely, lower interest rates will bring this zombie of an economy back to life, but the key word here is "slowly."
This economy has been in a three-year period of stagnation unprecedented in the postwar era. Since the first quarter of 1989, real gross domestic product has grown at an annual rate of just 0.5%, and growth in any one quarter has not been greater than 1.9%. That is a record of unrelenting economic malaise topped only by the 1980-82 period. But those years had a recovery sandwiched between two recessions.
More important, the past three years have seen sharp slowdowns in the growth of payroll jobs and household incomes that have squashed the three-year growth rate of consumer spending down to an annual pace of only 0.7%. The point here is that consumers hold the key to faster growth, but reversing the growth trends in jobs, incomes, and spending--in the face of burdensome debts, corporate restructurings, and a cautious Federal Reserve--will not come easily or quickly.
A couple of government indexes sum up the economy's story. The index of coincident indicators--those that track the economy's current path--dropped steeply in January, reflecting the first quarter's shaky start. However, the January index of leading economic indicators--those that point to future growth--posted a strong gain, suggesting better times ahead (chart).
The leading index rose 0.9% after posting small declines in three of the past four months. Seven of the 11 indicators that comprise the leading index contributed to the increase. Higher stock prices, more building permits, and gains in new orders for both capital equipment and consumer goods accounted for most of the advance. In contrast, the coincident index dropped 1% in January, to the lowest level in 4 1/2 years.
One immediate problem is excessive inventories held by retailers and wholesalers last quarter that are depressing output this quarter. The Commerce Dept. says real GDP rose at an annual rate of 0.8% in the fourth quarter, instead of 0.3% as reported a month ago. However, faster inventory growth fueled the upward revision, while overall spending was revised down.
Nonfarm inventories rose by $12.5 billion last quarter--far greater than the $3.6 billion increase initially reported. The breakdown shows that manufacturing stockpiles actually fell by $9.9 billion, but retail and wholesale inventories jumped by $23.7 billion (chart). The pileup of nondurable retail goods was especially large.
With retailers and wholesalers awash in a sea of inventories, ordering to factories has fallen off, and manufacturers are trimming their own stock levels. Factory inventories fell 0.3% in January--the fourth consecutive drop. That's why industrial production declined in November, December, and January. Without a faster pace of consumer spending to help lighten inventories, more output cuts will be necessary.
The February report from the National Association of Purchasing Management suggests that the recent weakness in manufacturing may be bottoming out. The purchasing managers' composite index of industrial activity rose to 52.4% last month, from 47.4% in January. A reading greater than 50% means that manufacturing is growing. The NAPM's readings of production and new orders both rose smartly in February.
But it's still not clear if those gains are broad or sustainable. Auto production was probably the biggest boost for February output. Carmakers cut their January production to an annual rate of 5 million from 5.6 million in December. That took a big bite out of industrial output in January, but based on Detroit's February schedule, car production bounced back to 5.6 million.
Beyond autos, the factory outlook is less cheerful. Factory orders in January rose 0.4% from December, but a 1.4% drop in bookings for nondurable goods offset the month's 2.2% gain in orders for durable goods. That was the second consecutive decline in nondurable orders--a result of the inventory overhang at retailers.
For manufacturers of nondurable goods, the ratio of inventories to sales rose sharply in December and January. That suggests more production cuts in that sector.
Consumers weren't eager to spend in January, and unless incomes begin to rise faster, households will not be able to supply the thrust that the economy needs. Real consumer spending for goods and services, adjusted for inflation, rose a mere 0.1% in January.
Services accounted for all of the month's slim gain, while outlays for goods were unchanged. Purchases of goods had declined at an annual rate of 4% in the fourth quarter, and no gain in January means that retailers and wholesalers didn't make much progress toward cutting their bulging inventories down to size.
Initial readings for February show that consumers did step up their car buying, but only a bit. Sales of domestically made cars rose to an annual rate of 6.2 million in February, from 5.9 million in January. But that's still a subdued pace. Until car sales rise back to the 7 million rate, doubts will remain about the general readiness of consumers to lead an upturn.
To do that, consumers need more income. Personal income dipped 0.1% in January after a big gain in December that was fueled by onetime factors. After inflation and taxes, real income has grown at an annual rate of 1.7% since October. That pace is an improvement over previous months, but it won't support much spending.
Moreover, without a lift from transfer payments--income from Social Security and various income-support programs--real incomes have been trending down in recent months (chart). From September to January, overall real income has risen by slightly more than $18 billion. Excluding transfers, real income has fallen by just under $18 billion. Growth in the important wages-and-salaries component of income has been about flat, reflecting poor job growth.
Although sluggish income growth is keeping a lid on everyday consumer spending, that hasn't deterred some consumers from taking advantage of the lowest mortgage rates in more than a decade. Sales of new single-family homes jumped 12.9% in January, to an annual rate of 612,000--the highest level in two years (chart).
Curiously, sales of existing homes dipped slightly in January, to a 3.2 million annual rate. But the logjam in mortgage applications during the month may have pushed many closing dates into February.
A more serious problem for the housing recovery is the recent backup in interest rates. The average rate on 30-year mortgages in late February had risen to nearly 9% from a 17-year low of 8.3% in mid-January. The Mortgage Bankers Assn.'s index of mortgage applications for home purchase had more than doubled from December to late January. But by late February, the index had dropped by 25%. That may be signaling a sales slowdown in February.
Ultimately, consumers will have to see job-market conditions and income prospects improve substantially before a meaningful economic recovery can take root. Right now, many sectors are improving bit by bit. But by summer, a little here and a little there might just add up to the real thing.JAMES C. COOPER AND KATHLEEN MADIGAN