Loosen Your Seat Belt, The Second Half Should Be A Smoother Rideby
Alan Greenspan the economist well understands the perils of forecasting. But Greenspan the Federal Reserve Board chairman apparently doesn't. He told Congress on July 20 that growth in second-quarter real gross domestic product "clearly has run in excess of 2.5%." On July 29, the Commerce Dept. reported that real GDP rose a lackluster 1.6%.
The chairman's flub, however, may look less embarrassing after future revisions, including Commerce's annual benchmarking due on Aug. 31. Several sectors--among them consumer spending, housing, equipment investment, and the trade deficit--were improving toward the end of the quarter. That suggests an upward revision.
To Greenspan's credit, though, the tone of the GDP report is far more upbeat than the top-line number suggests. In fact, the breakdown between demand and inventories strongly suggests that the economy is poised for second-half growth in the neighborhood of 3.5%.
Looking further ahead, the outlook for 1994 is now a shade brighter as well, because the upheaval in Europe's exchange-rate mechanism all but guarantees lower European interest rates. That's bullish not only for European growth but also for U.S. exports and manufacturing.
Stronger foreign demand will provide yet another offset to the contractionary impact of the Clinton Administration's deficit-cutting budget proposals. That's in addition to the sizable stimulus to domestic spending from the drop in long-term interest rates so far this year, much of which has yet to percolate its way through the economy.
For the rest of 1993, the upbeat implications in the second-quarter GDP report are hard to deny. For starters, final demand--the sum of spending by consumers, business, government, and foreigners--rose at an annual rate of 3.7%, more than reversing the 1.2% drop in the first quarter.
As a result, the ominous first-quarter bulge in inventories all but evaporated (chart). That means most of the cutbacks in orders and output that were necessary to cut stockpiles down to size are now complete.
The implication is that second-half output is free to grow in line with demand, which appears to be back on a solid footing. Manufacturing will reap the benefits. Factories have been in a slump in recent months, partly reflecting the inventory correction.
In particular, auto production is ready to make a big contribution to factory output. After rising at an annual rate of $16.8 billion in the first quarter, car dealers' inventories fell by $6.9 billion in the second. That swing alone accounted for all of last quarter's slower pace of inventory growth, and it opens the way for Detroit to rev up for its robust third-quarter production schedule.
Already, the government's reading of June factory orders has shown some bounce, and for July, the National Association of Purchasing Management had more good news. The NAPM's index of industrial activity rose to 49.5% last month, up from 48.3% in June. The overall index remained just below the 50% line dividing expansion from contraction, but the orders index jumped to 53.1%, from 49% in June (chart).
For now, though, manufacturing's depressing influence continues to show up in the data. The government's index of leading indicators, for example, is heavily weighted toward factories. In June, the index rose only 0.1%. Although that's an improvement over the 0.4% drop in May, the index is still 1% below its February peak--about the time manufacturing began to weaken.
Demand strengthened in nearly all major sectors last quarter except defense and net exports, which remained weak. But even on the trade front, exports advanced at a healthy 6.7% annual rate, despite slumps in Europe and Japan. But rising imports washed out that gain.
In the second half, weakness abroad will limit export growth, but the pace of imports should slow, given their sharp acceleration in the first half. Trade looks like a net zero for growth, but that's an improvement over the first half, when a wider deficit lopped nearly a full percentage point from real GDP growth.
Three clear contributors this half will be consumer spending, housing, and business investment in equipment. In particular, equipment outlays will continue to be a growth leader. They rose at an annual rate of 16.5% last quarter, equal to the average advance for the past five quarters. Where's the money going? The highest priority on companies' capital budgets is spending for information processing and other high-tech machinery, which is aimed at cutting costs and improving productivity. Low interest rates and rising profits will continue to fuel the investment boom.
One surprise in the GDP data was a stronger-than-expected performance by consumers. Real spending grew at an annual rate of 3.8% last quarter, compared with a rise of just 0.8% in the first. In June alone, inflation-adjusted outlays increased 0.6%. Over the past year, consumer spending is up 3.3% (chart), and an essential ingredient in the second-half outlook is that shoppers maintain that healthy buying rate.
For now, the signs suggest that consumers will carry the ball in the second half, because future job and income growth will be more in line with spending gains. In the first half, outlays rose at an annual rate of 2.1%, but real aftertax income grew by half that pace.
Over the next six months, though, payrolls should grow by an additional 1 million jobs, or a shade faster than the 1.8% growth rate in the first half. And because wage gains have firmed up in recent months, real aftertax income will advance a bit faster than its 1% rate in the first half. The combination of more hiring and better pay means that income growth will be strong enough to support consumer spending growth in the 3%-to-31 2% range in coming quarters.
One beneficiary of the stronger consumer fundamentals is the housing industry, and that won't change. New single-family home sales rose by 11% in June, to an annual rate of 678,000 (chart). And mortgage applications were strong in July, thanks to lower rates.
Homebuilding was a drag on the second-quarter GDP total, falling at a 9.5% annual rate. But that weakness was the result of the harsh winter, which curtailed housing starts in the first half. Now that demand has picked up, inventories of unsold homes are low, and construction will be a plus in the second half.
Nonresidential building won't fare as well. High vacancy rates for offices and low factory operating rates will keep investment in business structures down. Outlays rose at a 4.8% annual rate in the second quarter--perhaps a sign that the three-year slump in this sector may be bottoming out. But outlays are still 2.3% below their year-ago level.
Looking at recent monthly data, however, the construction industry overall may have been a bit busier last quarter than first measured. Spending rose by a strong 1.2% in June. And May's numbers were revised up to show a 1.1% rise instead of 0.4%. Also, contracts for future building jumped 13% in June, according to F.W. Dodge Group of McGraw-Hill Inc. That was the largest gain in 11 2 years.
Public-works projects accounted for most of the June increase and the May revision. That spending suggests that government purchases, up only 0.5% last quarter, may actually have added more to GDP growth.
Whether or not future GDP revisions vindicate Greenspan's off-center forecast for the second quarter, the real issue is the second half. Right now, two things seem clear about the rest of 1993: One, Greenspan won't be tossing out too many forecast numbers. And two, based on the evidence so far, growth is shaping up to be a lot better than it was in the first half.