A Sweet Surprise For U.S. Industry

As a company that has logged $1.2 billion in losses over the past three years and just began cutting 15,000 jobs, Delta Air Lines Inc. wouldn't seem to have much to cheer about. Wrong. Passenger traffic is jetting ahead on Delta's international and domestic routes--up 13% and 4.5% respectively in May. Better yet, Delta is looking at double-digit increases in bookings for the crucial summer travel season, even for its long-troubled North Atlantic service. "We expected bookings to be strong, but they're a lot better than we anticipated," says Robert W. Coggin, Delta's senior vice-president for marketing. "There's a lot of pent-up demand out there."

Delta is not alone. From semiconductors to steel, U.S. industry is finding business surprisingly strong, despite four interest-rate hikes by the Federal Reserve since February and market jitters over the resurgence of inflation. Big manufacturers such as Caterpillar Inc. have been running plants all-out, while capacity-pinched Chrysler Corp. is even turning away orders. "Economic growth will continue," says Henry B. Schacht, chief executive of Cummins Engine, which is experiencing its strongest demand in a decade.

REFRAMED FORECASTS. To be sure, some industries, such as commercial aircraft manufacturing, remain in a slump. But others have discovered that business will be mildly above plan, at least for a while. The U.S. auto industry is expected to produce up to 15.2 million cars and light trucks this year--500,000 more than forecast six months ago. And projections of chip industry growth this year have been raised a solid six points, to 20%.

And what of those interest-rate fears that have so roiled the U.S. bond market? "So far, they haven't affected our capital-investment plans," says Marvin Burkett, chief financial officer of Advanced Micro Devices Inc., which is spending $1.4 billion on two chip factories in Texas and Japan. And while would-be homeowners may be wary, higher rates haven't choked off the nascent recovery in commercial real estate. "Two months ago, [real estate] borrowers were hesitating, but then the whole market shifted, and people went right along with it," says Richard C. Clotfelter, president of CB Commercial, a big commercial real estate broker that has seen its sales jump more than 40% so far this year.

Indeed, a new BUSINESS WEEK/Louis Harris & Associates Executive poll shows that top managers are far from fearful of the economic future. Fully 90% of the 401 senior executives surveyed were optimistic about the outlook for the U.S. economy in the next year, up from 83% in a similar query last December. Likewise, only half of the executives polled expect long-term interest rates to increase over the next 12 months, compared with two-thirds of the respondents six months ago.

Such optimism is bolstered by some recent economic data. Industrial production posted its 12th consecutive monthly increase in May. The jobless rate fell 0.4%, to 6%, in May, while first-time claims for unemployment benefits recorded an unexpectedly large drop in early June. Manpower Inc.'s third-quarter survey of 15,000 companies found that 29% plan to hire workers this summer, the most bullish forecast since 1989. And with strong activity in the South and West, housing starts logged a surprising 2.6% increase in May, to an annual rate of 1.51 million units.

Evidence of continuing strength also is showing up in service businesses. Cintas Corp., which provides uniforms for 1.4 million American workers at companies such as Albertson's Supermarkets and Southwest Airlines Co., is seeing its market expand. "In the last six months, for the first time in five years, our customers are growing," says Chairman Richard T. Farmer.

The downside is that after slashing staffs and shuttering factories, many U.S. companies are facing a capacity crunch. As they scramble to keep up with surging industrial demand, U.S. steelmakers are importing unfinished slabs from overseas. PaineWebber Inc. estimates that steel imports could reach 25 million tons this year, up from 19.5 million last year.

Auto capacity is tight, too. Driven by high consumer demand and low lease rates, Detroit racked up stronger-than-expected 20% sales growth in the first quarter. Sales have cooled a bit, partly because of a shortage of models such as the Chevrolet Lumina and Ford Tempo, which are undergoing model changeovers. Still, Chrysler has 273,000 orders it can't fill for 1994-model cars and trucks. Overall, auto makers plan an 18.9% increase in third-quarter production, despite higher finance rates.

RETAIL TIGHTROPE. Bottlenecks have allowed some industries wide latitude in pricing. Building-materials giant USG Corp. has raised drywall prices in each of the past eight quarters--for a total increase of 33% in just two years. USG is running most of its plants three shifts a day, seven days a week. "For us the bellwether is consumer confidence, rather than interest rates," says Vice-President Matthew P. Gonring. "Confidence is still high, and we have not revised our forecasts downward."

The chance that such aggressive price rises might become widespread is one reason Fed Chairman Alan Greenspan and U.S. bond markets have been so edgy. But import competition and excess foreign capacity should keep most industries from raising prices too much. Steelmakers have announced a modest 3% price increase effective July 1.

Most industries that cater to consumers are wary of price hikes, though. Recent healthy airline traffic, for example, is due in part to a 5.4% price decline in May, the largest one-month drop in airfares in 25 years. "The competitive situation in the retail industry is such that it's very difficult to raise prices," says Sears, Roebuck & Co. CEO Edward A. Brennan. "In fact, we're seeing price deflation [on many goods]."

Indeed, retailers and others realize they are walking a tightrope at this stage of the recovery. Small interest-rate increases have relatively minor immediate impacts: A one-percentage-point rise in finance rates boosts the monthly payment on the typical auto loan by only $7, according to Salomon Brothers Inc. analyst Jack V. Kirnan. But rising rates can chip away at consumer confidence. And mortgage refinancings, which helped fuel last fall's spending binge, have slowed sharply. "With the refinancing game over, consumers are looking at a less optimistic future where they'll have to expand their debts," says First Chicago Chief Economist James E. Anabel.

Even if consumer demand fades later this year, many U.S. businesses can look to exports to pick up some of the slack. European Union economies are expected to expand by 1.6% this year, after a 0.3% contraction in 1993. And demand in Japan finally seems to be picking up. "Now the stagnant economies of the world seem to be recovering--soft recoveries, but recoveries nevertheless--which should help U.S. exports," figures Allen L. Sinai, chief economist at Lehman Brothers Global Economics.

Still, many worry that the Fed's action to head off inflation may end the party prematurely. Such moves could be particularly dangerous next year, when many economists fear that lagging real income growth and increased tax payments could force consumers to rein in spending. DRI/McGraw-Hill predicts that real gross domestic product growth could fall to a slim 1.9% in 1995. "What keeps us out of recession is that the Fed hasn't tightened too much," says DRI economist David A. Wyss. "My worry is that if the economy strengthens a bit more and the Fed tightens too much, we could get a recession toward the end of next year." Just as bad, the weakening dollar could force the Fed to raise rates sooner than warranted by the domestic economy.

LESS TORRID. For now, wholesale and retail sales and other data suggest that higher rates are slowing the economy only slightly. Sinai predicts that growth in GDP will average 3.5% for 1994. That's well below the torrid 7% GDP growth of late 1993--but still respectable.

And more sustainable. "If you have a stable economy in which consumer psychology is good and people feel they're going to keep their jobs, they buy homes," says Leonard Miller, chairman of Lennar Corp., Florida's largest builder. "I see it as a good market for homebuilders--not for record starts, but for sustainable growth."

For many U.S. industries already wowed by the economy's vigor, a sustained expansion would be the most welcome surprise of all.

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