With the average length of an expansion at 4 1/2 years, the current up-cycle, which turned 8 this month, is an old-timer. In fact, only one upturn in the postwar era lasted longer. But even at this mature age, the expansion is enjoying vibrant domestic demand and surprisingly low inflation. That remarkable combination is unheard of at this late stage of a business cycle, when production bottlenecks and labor shortages are usually triggering a runup in inflation.
Better still, the latest data suggest that this good fortune will continue. Yes, economic growth is easing up from its 6.1% spurt in the fourth quarter, but the slowdown looks pretty peppy. Shoppers are crowding stores (chart). Manufacturing is creeping back, helped by lean business inventories. And housing, although down from its record pace of 1998, is operating at a high level. At the same time, inflation is virtually nonexistent, and import prices seem to be falling again.
For Wall Street, healthy demand and low inflation are a win-win situation. A 10,000 Dow Jones industrial average is no longer a wild-eyed dream. And long-term interest rates are down because the bond market believes that the Federal Reserve will not have to hike short-term rates, perhaps for the rest of 1999. That belief was bolstered on Mar. 16, when Fed Chairman Alan Greenspan, speaking in San Francisco, seemed to indicate monetary policy was on hold for now.
Certainly, not all the news is good. Corporate profits are anemic because businesses cannot raise prices enough to offset rising labor costs. The rest of the world remains in chaos, and falling foreign demand is damaging U.S. exporters. While these factors are not new, it's important to remember that future profits and global uncertainties have great influence on the stock market and inflation. And right now, they are the most vulnerable elements in the outlook.
DOMESTIC DEMAND, on the other hand, looks invincible. Retail sales jumped 0.9% in February, and January sales were revised to show a 1% gain, instead of the puny 0.2% increase originally reported.
Retail sales volume is on track to grow at an annual rate of 11% in the first quarter, especially since weekly surveys show that March retail buying is also doing well. Since goods account for just less than half of total household purchases, real consumer spending may be growing in excess of 4% this quarter. If so, real gross domestic product is more likely to be increasing at a rate above 3% than below it.
Vehicle buying was especially robust in February, but all the sales categories racked up impressive gains. Once again, purchases of building materials, furniture, and appliances rose strongly, reflecting the housing boom. That demand for home-related goods will grow further this year, since consumers continue to furnish their new homes for months after buying them.
Demand for houses may soon be easing up, though. The National Association of Home Builders' Housing Market Index fell for the third straight month, to 69% in March (chart). All three components--current sales, expected sales, and buyer traffic--declined. The index is back to its level of last spring. But even then builders were breaking ground for new houses at a 1.6 million annual rate. That's hardly a shoddy number.
And, at least in early 1999, homebuilding remains a contributor to GDP growth, helped by mild winter weather. Housing starts dipped 0.6% in February, to an annual rate of 1.8 million, but starts this quarter are running above their fourth-quarter average. In addition, single-family starts rose in February for the fifth month in a row, to a 20-year high of 1.41 million.
THE CONSUMER AND HOUSING BOOMS kept some manufacturers afloat in 1998, even as global turmoil crippled exporters. For 1999, that split will probably remain. But the worst from the Asian crisis seems over even as Latin America becomes a question mark.
Total industrial production rose 0.2% in February, after no change in January. Manufacturing output alone also increased 0.2% last month--its fifth consecutive gain. Factory output last year was skewed by the strike at General Motors Corp. and the subsequent production rebound. But aside from that distortion, manufacturers seem to be gaining ground again (chart).
Not surprisingly, the biggest output increases are in industries that cater to domestic markets or that don't face much competition from imports. Those still losing are in trade-related sectors. So makers of appliances and computer-related goods are doing well, but output of basic metals, textiles, and chemicals is down. Oil and gas drilling is off a large 38.1% from a year ago, since falling oil prices worldwide are forcing companies to cap wells. Even within an industry, the effects of imports are evident: Light truck production is booming, but car output is rising only slowly.
The rosier outlook for manufacturing is helped by the lean state of business inventories. Extra goods stocked by manufacturers, wholesalers, and retailers grew just 0.1% in January, and the ratio of inventories to sales remains low. At the retail level, the January ratio dipped to 1.44, the lowest reading in 15 years.
EVEN IF PRODUCTION PICKS UP further, manufacturers and other businesses will face a hard time in 1999, in terms of profits. That's because they lack the power to raise prices high enough to make a buck in these days of increasing labor costs. Domestic demand may be hot, but slack foreign markets are holding down prices everywhere, including the U.S. In particular, with worldwide demand for raw materials down and with foreign producers selling at just about any price, U.S. commodity producers are getting squeezed.
Deflation problems are most acute at the wholesale level. Producer prices of finished goods fell a large 0.4% in February. Excluding food and energy, core prices were unchanged after falling 0.1% in January. Producer prices are rising from a year ago, but that mostly reflects the price hikes in tobacco products.
Recent data suggest inflation will remain mild. First, the dollar's rise since October may be exerting downward pressure on import prices again. Nonoil import prices dipped 0.1% in February. Second, business executives are downbeat about their pricing power. A National Association of Manufacturers survey revealed that 44.2% of their members say their product prices are falling. Only 28% said that a year ago. Consequently, a large 43.4% expect their profit growth to fall this year.
Weak profits remain a large fly in the economic ointment. So, too, does the financial turmoil around the world. But this expansion, old as it is, has been strong enough to shrug off these obstacles. And right now, nothing suggests that the expansion won't mark its ninth anniversary in 2000.