U.S.: Merry Christmas And An Iffy New Year

Shoppers are gift-wrapping the economy, but 1999 will be less cheery

With post-Thanksgiving reports showing that consumers are out in force searching for everything from the elusive Furby to the perfect cashmere sweater, the outlook for yearend household spending looks far brighter than it did a few months ago. Back then, the drop in the stock market and uncertainty about global finances hit consumer confidence hard and led many analysts to project a dreary holiday shopping season.

But look now. In a matter of weeks, aggressive interest-rate cuts by the Federal Reserve have breathed new life into stock prices and stabilized global markets, helping to clear out the air of doom and gloom that had weighed on households' psyches. That, plus continued healthy gains in purchasing power, means that consumer spending is on track to grow by at least 4% in the fourth quarter, perhaps yielding the strongest yearend shopping season in six years. All that holiday spending, plus a strong housing market (chart), could push the quarter's gain in real gross domestic product into 3% territory.

There are some Grinches in this holiday story, though. First, shoppers remain bargain hunters, so retailers probably won't see much improvement in their profit margins, even if stores are packed. Second, the factory sector remains beset by slumping foreign demand that is causing a production slowdown and layoffs. And third,shrinking corporate profits suggest that businesses will scale back their hiring just as they are rethinking their capital-spending budgets.

ALL THIS MEANS that the cheer of 1998 may not carry over very far into 1999. The latest news from the Boeing Co. shows why: The aircraft maker announced on Dec. 1 that because of weak Asian demand, 20,000 workers will be laid off by 2000, on top of 28,000 already slated to be let go. Its stock price then plunged on fears that 1999 earnings will not meet expectations. With other companies likely to follow Boeing's lead, a slowdown in the job markets will ultimately be the force that reins in the powerful consumer sector.

For now, though, consumer spending remains robust. In addition to more confidence in the economy, households are tapping sources of new cash in order to purchase more goods and services, including big-ticket items such as cars, homes, and home furnishings.

Certainly, fatter paychecks are providing a lift. Aftertax real earnings rose 3.3% in the 12 months ended in October, the fastest pace in 1 1/2 years. Many households are enjoying the swiftest advance in purchasing power in two decades, thanks to rising wages and low inflation. The recent drop in oil prices to about $11 a barrel simply strengthens that equation, freeing up even more income for holiday shopping.

But rising incomes don't explain all of the ongoing spending surge, since consumer purchases have soared by 5.4% over the past year, far outpacing income growth (chart). In addition to their salaries, households obviously are relying on gains from the stock market, as well as some timely extra cash provided by this fall's record wave of mortgage refinancings. The Dow Jones industrial average has come back from its September low, although there still appears to be some earnings angst among investors, as shown by the Dow's drop in early December.

FOR RETAILERS, however, these monetary windfalls have not changed a crucial part of consumer psychology in the 1990s. Shoppers are still very price-conscious. Most retailers will probably have to mark down many items in order to attract shoppers. And the discounting will mean that the booming holiday demand will not make it all the way down to the bottom lines of many retailers.

Consumers aren't just buying gifts, however. Home sales also remain very strong, even after a record-breaking pace in the spring. Sales of existing homes rose 2.1% in October, to an annual rate of 4.8 million, and new homes sold at a 851,000 annual pace, 0.8% above their September level. Residential construction, up 0.8% in October, led the month's 0.3% rise in overall construction spending.

The available data for November look equally solid. Mortgage applications to buy a home have slipped only a bit from their lofty levels of September and October. And homebuilders say their sales rose in November, setting a record. All in all, builders are extremely optimistic about both current business activity and their prospects in coming months.

MANUFACTURERS, however, are singing a more melancholy tune, as much of consumer demand is going to imports and as exports continue to sag. The November purchasing managers' index fell again and remained below the 50% mark, signifying that industrial activity is contracting. The index slipped from 48.3% in October to 46.8%, the lowest reading in nearly three years. Production took a big fall (chart), and the indexes covering orders, employment, inventories, and the order backlog all declined.

New data from the Fed, however, indicate that manufacturing's slump is not as steep as previously thought. Revisions to the Fed's measure of industrial production show that nonauto output rose slightly in the third quarter instead of falling. And the new data say that October output was about even with the third-quarter average, instead of below it. While factory production has slowed sharply this year, it has grown at an annual rate of 1.8% since the end of 1997, instead of only 0.3%, as the original data showed.

Sagging foreign demand is obviously the main drag on manufacturing. Price-adjusted exports in the third quarter were 2.1% below their year-ago level. That's the first year-over-year drop in 15 years. And the purchasers' export-order index in November remained near October's record low. Both readings were far below the 50% that indicates that orders are rising.


Until foreign markets get back on their feet, the U.S. economy will harbor a split personality. Overall domestic demand will remain positive, but manufacturing output and employment will suffer. That means that the holiday season will not be very cheerful for the 200,000 or so factory workers who have been pink-slipped so far this year. Moreover, a worsening foreign trade gap will continue to subtract a bit from overall GDP growth.

Consumers, however, seem ready to offset the weak foreign sector. That is the case this holiday season, when consumer fundamentals look as strong as they ever have in this expansion. To be sure, the roots of a slowdown are beginning to take hold. The profits recession, and its implications for corporate restructurings, will not go away anytime soon. But most consumers do not want to consider the prospect of a 1999 slowdown right now--not when there are gifts to wrap, trees to decorate, and Furbys to find.