Is That A Spring In Consumers' Steps?

It's April, when hope springs eternal and a forecaster's fancy turns to thoughts of recovery. Maybe it's just the time of year, but there are rumblings of a national mood swing out there. Both households and businesses are increasingly optimistic. Are people just fed up with being glum?

Hardly. The pessimism that ruled the attitudes and actions of businesses and consumers during the past year was rooted in real economic distress. Now, heightened optimism undoubtedly reflects some degree of economic improvement that people can see and feel. Two examples: Businesses are seeing healthier profits, and consumers are feeling fatter wallets.

Further evidence comes from the Commerce Dept.'s index of leading indicators. The composite of 11 separate measures that foreshadow business activity rose 0.8% in February, following a 1% jump in January. Those strong back-to-back gains, following five months of no growth, are a good sign that better times are ahead.

Consumers aren't dancing in the street, mind you, but their spirits are higher. The Conference Board's index of consumer confidence rose to 54 in March from 47.3 in February (chart). The University of Michigan's index of consumer sentiment improved as well, rising to 76 from 68.8 in February.

The Conference Board said that attitudes about households' present situation remain downbeat. In particular, almost half of those surveyed think jobs are "hard to get," the same shaky feeling as in February. The labor markets are crucial to the recovery's sustainability. Without steady job and income growth, this rebound could peter out as easily as the one last spring.

However, as was true with the Michigan report, most of the gain in the Conference Board's index reflects renewed optimism about the economy over the next six months. That's important because the reading of expectations has been a reliable forecasting gauge.


A big reason why consumers feel hopeful about their future is the extra cash in their wallets right now. Personal income surged by 1.1% in February, led by a 1.3% gain in wages and salaries. After adjusting for taxes and inflation, real disposable income was up a healthy 0.7%. Coming not too long after a 0.9% jump in December, the February gain in real earnings shows household buying power is clearly on the rise (chart).

The flood of mortgage refinancings that took place from late December to February is also funneling more money to consumers. Plus, the amount of tax refunds already paid out by the Treasury Dept. is almost twice what it was in January and February of 1991. With all that extra cash, it is no surprise that consumers went on a mini-shopping spree in the winter.

Real consumer spending jumped 0.9% in January and then increased by 0.6% in February. Big-ticket items, including cars, appliances, and furnishings, did extremely well.

Spending in March probably retreated. Unseasonably cold weather in many parts of the country hurt retail shopping. But even if real spending fell by 0.5% last month, real consumer outlays in the first quarter would increase at an annual rate of close to 5%. If so, that would be the largest gain in consumer purchases in four years, virtually guaranteeing a healthy uptick in the real gross domestic product in the first quarter.

Consumer spending is also likely to shift to a lower speed in coming months because income growth hasn't picked up as much as buying has. Even with the large February gain in pay, real disposable income is rising at a pace of only about 2.5% in the first quarter. And refinancings, which soared when mortgage rates were at 8%, have slowed to a trickle now that rates are up to 9%.


Rising interest rates add some risk to the housing rebound. But for now, it appears that higher rates will only restrain the sector's recovery, not derail it. Sales of new single-family homes slipped by 2.7% in February, to an annual rate of 613,000. But that followed an 11.1% jump in January, so home sales so far in the first quarter are running well ahead of their fourth-quarter pace.

Higher mortgage rates prevented some consumers from buying a home in February. Plus, house-hunters may be waiting to see if Congress enacts the White House proposal for a $5,000 tax credit for first-time home buyers. That plan seems unlikely to pass, but mortgage rates could ease down a bit by the summer. If so, home buying will pick up this quarter.

That means homebuilders will remain busy because demand could outpace the number of homes on the market. The inventory of unsold new homes fell to a 5.2 months' supply in February--the leanest inventory in nearly six years. And that's boosting builders' spirits.


Consumer optimism is contagious, because spending by households generates two-thirds of GDP. So it's easy to see why executives are feeling better about their businesses. A Dun & Bradstreet Corp. survey taken in February shows that virtually all industries and regions expect stronger sales and profits in the second quarter.

Moreover, the March report from the National Association of Purchasing Management looks upbeat. The NAPM's index of industrial activity rose to 54.1% last month, up from 52.4% in February (chart). A reading of more than 50% means that manufacturing is recovering. The purchasers said that while companies are not yet expanding their payrolls, new orders rose sharply for the second consecutive month. That's a good omen for future gains in jobs and output.

The promise of better profits is a chief reason for executives' rising optimism. In fact, businesses' bottom lines had already begun to look a little stronger at the end of 1991. The Commerce Dept.'s comprehensive roundup of fourth-quarter corporate profits shows that earnings before taxes dipped 0.3%, to $317.2 billion, but there's more to the story.

Operating profits--adjusted for depreciation allowances and inventory values--rose 3.4%. That means better cash flow. Operating earnings posted their largest quarter-to-quarter rise in three years. They now stand 6.9% taller than a year ago. Further gains seem assured.

Lower interest rates have helped to lift cash flow by cutting interest costs on debt. In particular, they have allowed companies to replace costly short-term debt with cheaper long-term debt. Interest as a percentage of cash flow for nonfinancial businesses has fallen from a record 34.5% a year ago to 29.9% in the fourth quarter. And the Federal Reserve's big rate cut on Dec. 20 undoubtedly resulted in a further decline in the first quarter.

Corporate America's profit margins are also beginning to improve. That could pay off big in the first half of 1992, as overall demand continues to pick up. Rising margins mean that companies are generating more profits per unit of output. Operating earnings of nonfinancial businesses as a percentage of their output rose to 7% in the fourth quarter, and they have been edging higher since the fourth quarter of 1990 (chart).

Margins should continue to fatten in 1992. Last year, prices rose by about 3%, while the growth in unit labor costs slowed to only 2%. That gap allowed margins to rise. This year, inflation is likely to remain at about 3%, while unit labor costs should slow further.

That's because wages and benefits are unlikely to accelerate much, if any, from last year's 3% pace, and the usual speedup in productivity growth that accompanies recovery will result in further moderation in unit labor costs. This means that many businesses will be able to boost profits even in a climate where pricing power is weak. That's another reason for optimism.

To be sure, no one is out doing the mambo on either Wall Street or Main Street. But the recent spate of better-looking data suggests that the rhythm of the economy has a little more swing to it.

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