Not Only A Merry Christmas, But A Happy New Year

Have you started your Christmas shopping yet? Judging by the recent strength in retail sales, many consumers are getting a jump on the holidays. Ringing cash registers are another in a bevy of good signs for fourth-quarter economic growth. More important, unlike last year, the economy's cheery afterglow is likely to linger well into the new year.

Why won't growth fade? For starters, businesses headed into 1993's final quarter with very lean inventories. Retailers will have to restock their shelves after the holiday season, helping to sustain the new momentum in industrial production.

Moreover, barring blizzards, floods, or other such disasters that hit the economy in 1993, demand will not collapse. Business investment in equipment, a leader in this expansion, may be slowing, but it's downshifting from a sprint to a run. Meanwhile, low interest rates and further growth in jobs and incomes will continue to support the new strength now developing in housing and autos (charts).

The fourth quarter is off to a strong start. In October, manufacturing output had already grown 5.6%, at an annual rate, above the third-quarter level. Price-adjusted retail sales stood 4.8% higher. And housing starts were up at a 30% rate. All this suggests growth in real gross domestic product of better than 4% this quarter.

In fact, there is a new question in the outlook: How much growth will the Federal Reserve tolerate before it feels the need to hike interest rates in order to thwart inflationary pressures? Perhaps more than the credit markets currently believe. Nearly all measures of economic slack show a lot of room for noninflationary growth in coming quarters.

That's especially true for the labor markets. Beginning with the data for January, 1994, the Labor Dept. will use new survey techniques to measure joblessness. A year's worth of experimenting suggests that the rate is about half a percentage point higher than the current 6.8%. Wage pressures typically do not begin to grow until the jobless rate nears 6%. The new data mean that this point is now further in the future, even at the recently improved pace of job growth.

However, the unlikelihood of better-than-4% growth in back-to-back quarters is the main reason most analysts expect no Fed action from its Nov. 16 meeting--or anytime soon. A survey of 35 economists by McGraw-Hill Inc.'s MMS International shows a 1 in 4 chance of a hike in the federal funds rate by the end of the first quarter.

Some slowdown next quarter is a good bet because of defense cuts, a widening trade gap, and corporate restructuring. Also, consumers might slow to a jog after their strong run in 1993, especially amid uncertainty over health care and taxes. But while growth may slow, solid fundamentals will prevent a collapse.

The biggest reason why the economy will not tank next quarter is the strength in housing and autos. Those industries have always been the economy's bread and butter because they support a broad range of secondary markets from sofas to spark plugs.

By all measures, housing demand continues to strengthen. The National Association of Realtors' index of housing affordability for the third quarter was the highest in 20 years. And after super sales gains in September, builders are getting busier.

Housing starts rose 2.7% in October, the third advance in a row, to an annual rate of 1.4 million. That pace, the highest since February, 1990, was fueled by a 5.8% jump in the key single-family-home sector. Single-family starts rose to 1.22 million, the most in more than six years.

In addition, the renewed interest of consumers in U.S.-made cars and trucks is supplying much of the fuel for the rebound in manufacturing. Output at the nation's factories, utilities, and mines jumped 0.8% in October, the largest increase in nearly a year. Output in manufacturing alone surged 0.9%, following gains of 0.6% in September and 0.1% in August. A 7.3% boost in production of motor vehicles and parts accounted for about half of the overall October rise.

But it's more than just autos. Output of other consumer durables jumped 1.3%, led by big gains in appliances and furniture. Output of business equipment scored a 1.4% advance, on top of September's 1.3% rise. Autos helped those gains, but production of information processing equipment also continued to increase strongly.

The upswing in output means that U.S. industry is using more of its capacity. The operating rate rose to 82.4% in October. That's closing in on the mid-80s reading that has been related to past inflation pickups. However, with imported goods now grabbing a record 24% of domestic demand, U.S. capacity readings alone are much less indicative of price pressures than are measures of global capacity, which is quite plentiful right now.

With demand already picking up, manufacturers won't despair if you're still working on that gift list. One reason: Retailers didn't go overboard on their holiday inventories this year. So stores are unlikely to suffer a merchandise hangover in January, as they did last year. That means new orders for goods should keep flowing to the factory sector in the first quarter.

Parking spaces certainly were hard to find at shopping malls in October. Retail sales jumped an unexpectedly large 1.5% last month. Car dealers, department stores, and gasoline stations all posted huge gains. Price hikes explain part of the rise, especially for gasoline. But even after adjusting for inflation, retail sales advanced for the seventh consecutive month (chart).

Merchants were busy early this month as well. U.S.-made cars and light trucks sold at a 12.4 million annual rate in early November, not much below the stellar 12.6 million pace for all of October. And the Johnson-Redbook Report says that department-store sales in the first two weeks of the month were up 1.4% from October.

In addition, both retailers and consumers are optimistic about yearend shopping, according to a survey done by Deloitte & Touche. The survey found that 50% of retailers expect to record higher sales this holiday season and that consumers plan to spend 5% more on gifts this year than last.

Stronger consumer fundamentals explain why there will be more presents under the tree. Job and income growth look better, and consumers have refinanced mortgages and paid off old debts, thus freeing up extra cash. In addition, the $6.7 billion surge in installment debt in September suggests that households feel comfortable with using their credit cards again.

Steady job growth, in particular, is why consumers won't desert retailers next year. Factory payrolls, which have already shrunk by 200,000 jobs this year, may finally have hit bottom. And because factories may have reached the limit on how much more output they can get by extending worktime alone, hiring looks likely.

That's true because lean inventories should keep factories busy in coming months. In September, business inventories rose 0.3%, while sales increased 0.8%. That pushed down the ratio of business inventories to sales to just 1.45, the lowest reading in 12 years (chart).

Store inventories alone grew by a bigger 0.8% in September. Most of the rise, though, came at retailers such as department stores that posted strong October sales, so part of the inventory was probably sold off last month. For the entire retail sector, the ratio mf inventories to sales looked manageable in September.

It isn't just low inventories, though, that argue for sustained growth next year. The same fundamentals that are fueling holiday shopping also make the case for a steady rise in consumer demand in 1994. Add in the lift from homebuilding and capital spending, and it's easy to see why the economy won't dim even after your loved ones have opened their gifts.