At This Rate, Santa's Elves Will Be Working Overtime

As soon as Americans could clear away their Thanksgiving turkeys, they hit the malls with Christmas on their minds. Initial reports suggest that the holiday season is off to a brisk start, and that's yet another sign that the economy still packs the kind of momentum it has shown throughout 1994.

In fact, the Commerce Dept. says that the economy had even more punch in the third quarter than was originally reported. Real gross domestic product grew at an annual rate of 3.9%, instead of 3.4%. As it turns out, Commerce had overestimated inventory growth, but the pace of final sales was much stronger. In particular, business investment grew twice as fast as first thought (table). Revisions to the inflation measures were minor.

Although growth is widely forecast to be slower in 1995 than this year, the extent of that slowdown--and the response by the Federal Reserve--will be determined largely by consumers. Households have been a driving force in this expansion since mid-1993, and for any lasting downshift in growth, consumers will have to dial back their energetic spending pace.

So far, though, even after a big increase in outlays last quarter, shoppers show few signs that their batteries need recharging. What's keeping consumers going and going? For one thing, better income growth. Strong labor markets fueled big income gains in October. Consumers are also feeling more confident about the economy, and they have embraced the use of credit cards again--if only to accrue such goodies as discounts and frequent-flier miles.

Consumers' spirits certainly looked more effervescent in November. The Conference Board's index of consumer confidence surged to 101.3, up from October's 89.1 (chart). The leap was the largest one-month advance in almost two years and pushed the index to its highest reading since July, 1990.

CONFIDENCE in the economy's present situation bounced up--by more than 17 points, to 108.3--last month, and expectations about the future jumped to 96.7, up from 87.9 in October. The Conference Board said the year's interest-rate hikes by the Federal Reserve have not yet dampened the mood of consumers and that a higher percentage of those surveyed thought employment gains would be stronger in the months to come.

The Republican Party's triumph in the congressional and gubernatorial elections may have brightened views on the economy's future. Few things boost consumers' spirits more than talk of a tax cut.

This renewed confidence, especially over job prospects, is helping to support spending this quarter. Both the Mitsubishi Bank-Wertheim Schroder index and the Johnson Redbook Report found that retail sales increased strongly during the week ended Nov. 26.

And reports showed hefty gains in credit-card use and checks written on "Black Friday," as retailers call the day after Thanksgiving that opens the lucrative holiday season. Visa USA Inc. said charges on its credit cards for the combined Friday and Saturday period hit a record $1.9 billion, up 24% from last year, while MasterCard volume on Friday jumped 35%.

Of course, one week's data are not enough to label the season a big success, and this quarter is unlikely to match the fourth quarter of 1993, when real retail sales exploded at a 10.8% annual rate. But the early activity does suggest retailers will not be disappointed.

In a separate survey, the Conference Board reports that households plan to spend 7% more on gifts this year than last year. That increase, which is in line with most forecasts of a 6%-to-8% gain, means holiday sales should reach nearly $42 billion this year. That's a lot of espresso makers and Power Rangers.

ONE DOWNER for shopkeepers could be that 1994 will require heavier sales promotions than 1993. Stores went into the season with unusually large inventories, which will have to be moved out with various discounting schemes--cutting into profits.

Also, interest rates are not immaterial to shoppers. Higher rates are having a strong effect on the biggest consumer purchase of all: houses. Sales of existing homes eked out a 0.5% gain in October, up to an annual rate of 3.91 million.

Home-buying has dropped off, however, since its frenzied pace of late 1993. Resales fell 1% in both August and September, and the October total was 3% below the rate of a year ago. House prices are, on average, only slightly higher than their level of October, 1993.

The slowdown in housing demand, along with the need to pay off Christmas credit-card bills, means that consumers may rein in their spending come the first quarter. But as long as the fundamentals--including jobs, incomes, and confidence--remain buoyant, the pace may not dip very much for very long.

RIGHT NOW, consumers are helping to keep manufacturers busy--and keep their order books full. Although bookings at durable-goods factories dipped by 1.5% in October, the volatile transportation sector more than accounted for the decline. Orders in all other major sectors rose--from metals to machinery to electronic equipment. Bookings began the quarter well above their third-quarter average.

Moreover, factories have a growing pile of unfilled orders. Outside the aircraft industry, the backlog has soared more than 5% so far this year, after a steady downtrend in previous years (chart). That's a key reason for this year's pickup in factory hiring. And it means that further gains in jobs and output are likely.

The Federal Reserve's annual revisions to industrial production and capacity did little to change that outlook. The changes in the monthly pattern of output were slight, especially in 1994, and the rate of capacity use for all industry in October is now 84.6%, down only a shade from the 84.9% recorded before the revisions.

Increased activity in manufacturing and other businesses continues to bump up the bottom line. The Commerce Dept.'s measure of corporate operating profits, adjusted for changing inventory values and depreciation, rose 12.9% for the year ended in the third quarter. Strong earnings growth is a major reason why companies continue to shell out big bucks for new buildings and equipment.

Thanks to productivity gains, which are holding down unit labor costs, profit margins remain historically high. For nonfinancial companies, the ratio of operating earnings to real output rose to 12.8% last quarter, up from 12.7% in the second quarter.

To be sure, profit growth will slow sharply in 1995, if only because the Fed is hard at work hiking interest rates in order to cool off consumers' yen to spend. And judging by the strong start to the holiday shopping season, even higher rates will be needed to force households to pull back.

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