Starting The New Year With A Bit Of A Hangover

As New Year's Day often proves, excess can be costly. The same is true for the economy. But instead of suffering a headache from too much champagne, the economy is coping with an inventory hangover due to overproduction. It's also hurting from a cooler pace of consumer spending brought on by slower job growth and credit-card bills rung up during the holidays.

These problems continue to box in the nation's industrial sector. The latest tidbits of economic data--culled from private sources since the government shutdown has delayed all official releases--show that the economy grew at a sluggish pace in the fourth quarter. What's more, that softness seems likely to extend right into early 1996.

Factories scaled back their production in December, but domestic demand was equally soft. So inventories probably remained somewhat excessive, and producers will have to lower output schedules again this quarter. Still, despite worries about consumer debt, the economy seems unlikely to drop into a recession.

SLOW GROWTH IS THE WORD from the December report of the National Association of Purchasing Management--the most important data to be released since Shutdown II began. The NAPM's composite index of industrial activity rose to 47.3% in December, from 46.5% in November, but any reading below 50% suggests that the industrial sector is contracting.

Of the individual components, the NAPM's production index, while up from November, was low enough to suggest that production fell last month. And the more forward-looking new-orders index slipped to 45.9% in December, from 50.1% in November, indicating that factory activity remains in the doldrums.

Factory payrolls still look to be under pressure. The NAPM's employment index improved to 47.2%, from 44.1%. It takes a reading above 47%, over time, to suggest that factory payrolls are rising. And because the Labor Dept.'s employment release scheduled for Jan. 5 has been indefinitely delayed, the NAPM report is the best available sign that, at the very least, manufacturing jobs were flat last month.

One bright spot in the economy remains the foreign sector. The NAPM's export index rose to 57.4% in December--the highest reading since July (chart). Strong foreign orders reflect better growth prospects overseas, especially in emerging markets. Given the global technology boom, it is not surprising that the NAPM reveals that industrial and commercial equipment and computers as well as electronic gear were key industries reporting increased export demand.

Factory inventories declined in December, but at a slower rate than in November. And there was another telltale sign that the gifts under the tree last year weren't the usual Christmas largesse: The NAPM indicates that inventory gains were largest in the miscellaneous category, which includes items such as jewelry, toys, sporting goods, and musical instruments.

With slowing demand and high inventories, companies were able to fill orders quickly. The supplier delivery index stood at 48.3% in December. That's above November's 45.8%, but any reading below 50% indicates delivery times are short.

The imbalance between sales and goods-on-hand also means that pricing power continues to wane. The index of prices paid slipped to just 40.8% in December. That's the lowest reading in 4 1/2 years, and just half the index's level in the first quarter of 1995.

The NAPM data echo the weakness seen in other recent private-sector reports. The American Production & Inventory Control Society's manufacturing index slipped in December, and the Association for Manufacturing Technology says that orders for machine tools dropped in November. And according to the Johnson Redbook Report, retail sales at department and discount stores for the entire month of December finished 0.6% below their November level.

THE WEAK READINGS on production, price pressures, and retailing heighten expectations that the Federal Reserve will cut short-term rates again at its next policy meeting on Jan. 30-31. The Fed trimmed its federal funds rate on Dec. 19 by a quarter-point, but the malaise setting in now suggests another slice, especially if a credible deal to cut the deficit emerges.

Lower rates could diminish one consumer worry for 1996--high debt levels (chart). But even five years of growth have not made job security a sure thing. These two factors are likely to limit the gains in consumer spending but not trigger a tailspin into recession.

The Jan. 2 announcement of 40,000 layoffs made by AT&T highlights the precarious position of workers. The surprisingly large and involuntary job cuts may shake consumer confidence in the economy in January.

IN ADDITION, CONSUMERS now face their biggest debt burden in nearly four years. Installment debt has increased by $225 billion in the past two years, and home mortgages are up by nearly $300 billion.

Even with the decline in interest rates in 1995, the cost of paying off these two types of debt had risen to 16.8% of disposable income by the third quarter, up from 15.9% a year ago. Given the continued increase in credit-card use, debt service probably rose further in the fourth quarter. Credit-card and mortgage delinquencies are also on the increase.

However, this debt burden is still below the level that signals trouble. For one thing, delinquencies are limited to a small percentage of households. Also, the bond-market rally and the December easing by the Federal Reserve will offer some relief in coming months. Finance charges may slip a bit because so many credit-cards have adjustable rates that are tied to the prime, which banks trimmed by a quarter-point--to 8.5%--right after the Fed cut.

Equally important is the cash-flow boom to homeowners who are refinancing in the wake of the bond-market rally. Thanks to 30-year mortgage rates slipping below 7%, refi madness is reigniting. To be sure, this wave does not equal the 1993 gold rush, yet. But by the end of 1995, the value of refinancings was already seven times bigger than in the first quarter of the year, according to the Mortgage Bankers Assn. (chart).


Refinancing a $100,000 mortgage from, say, 8.5% to the current 7% can free up $105 in the monthly budget. Moreover, if long rates continue to slip--and right now it seems as if only a failed budget agreement will short-circuit market sentiment--then even more mortgages will be refinanced. That will mean extra money to keep consumer spending on a slow but steady upward trend.

The budget agreement, however, remains a big "if" on the economic landscape. Until Washington's number-crunchers get back to work, policymakers and private economists must examine all data shards to see how the expansion is doing. Right now, the private reports suggest that the economy is slowing. Perhaps soon we will have some government data to confirm or deny that view.

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