Can The Economy Keep Dodging Bullets?

It was a year of paradoxes and contradictions: In 1998, global financial markets started to melt down, but the U.S. economy kept humming. Profits weakened, but the stock market staged an impressive recovery. Personal savings dwindled to nothing, yet consumers felt flush and kept spending. President Clinton was impeached by the House of Representatives, and the markets shrugged. Yet there is an underlying logic to economic events in 1998, and to how they are likely to play out in 1999.

Last year's recessions across Asia, followed by the summer's parade of financial crises from Russia to Brazil, were worrisome. Experts feared the U.S. wouldn't emerge unscathed and would surely begin to feel the pain of plunging foreign sales and jittery markets. Instead, the U.S. was terra firma, bulwarked against the stormy seas. Well-timed easing by the Federal Reserve helped, but more important was the economy's inherent strength. Unemployment was low, inflation tame, and productivity growth strong. Output grew about 3.5%, following two equally stellar years.

There's no guarantee that growth rate can be sustained, of course. A BUSINESS WEEK poll of executives for this year's Industry Outlook suggests that a greater percentage are pessimistic than were pessimistic a year ago. Growth in capital spending is slowing down. But with pricing power constrained and companies embarking on cost-cutting programs, productivity gains should be respectable in 1999. The U.S. economy could yet beat the consensus projection of 2% growth this year.

The profits picture is similarly understandable on closer inspection. Last year, profits were dented by one-time write-offs and other potholes in the road. Yet the stock market managed to rally in the year's final months. Again, the Fed played a role. Then, too, the longer-term prospects for some companies--especially some Internet companies--drove those stocks all the way to the stratosphere. Given a sufficiently long view, who knows? Maybe these companies will prove out.

As 1999 progresses, year-over-year profit comparisons for all companies should look better. At the same time, though, the earnings estimates that analysts put out--they've figured a rise of 17% this year--may be reduced. Don't be worried. In the world of earnings reports and analysts' estimates, it's common for analysts to play an expectations game.

The apparent profligacy of the American public isn't quite what it seems at first blush, either. Yes, the reported savings rate dipped below zero for a couple of months in 1998. No, this did not signal a descent into financial irresponsibility. The savings rate is a faulty measure that fails to capture capital gains and the benefits of mortgage refinancing. The stock market's huge rewards, as well as home-price appreciation, have padded wealth to a phenomenal degree in the 1990s. But it turns out people didn't even need that cushion. Total wage and salary gains, not adjusted for inflation, grew 6.7% in 1998, outpacing the 5.5% gain in consumer spending.

Finally, there's the dissonance between Washington and Wall Street. Again, it's not surprising if you think about it. For one thing, investors figure that reason will eventually prevail, with some sort of deal that spares the nation a long, drawn-out trial of President Clinton. More fundamentally, market participants probably know better than to worry too much about Clinton's fate. If Alan Greenspan were in trouble--now that would be reason for concern.

The most immediate items on Washington's economic agenda--health care and Social Security reform--will be put on hold while the Senate deals with impeachment. Given the rancorous debate that is likely to erupt over these issues, delay might not be such a bad idea. That way, Congress and the experts may be able to better judge the economy's strength. The way things have been going, they might just be surprised.

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