There's New Life In The Old Boom

A surge in capital spending has experts upping '99 growth forecasts

Six months ago, Ryder System Inc. was resigned to a mediocre 1999. Its forecast was for the U.S. economy to slow to an anemic 1% growth rate. But five weeks into the new year, Miami-based Ryder has thrown that prediction away. Business "is as strong as we have ever seen it," exults Chief Executive M. Anthony Burns.

And as Ryder goes, so goes the nation, since deliveries by its 175,000-truck fleet reflect everything from manufacturing to retail to capital equipment. "We're a very good indicator of demand," says Burns. "Not only are people seeing good business today, they're even optimistic about the longer term."

Ryder isn't alone in doing a double take. Just last December, the consensus forecast of 55 economists surveyed by BUSINESS WEEK was for growth of just 1.9% this year, half the pace of the previous three years. But in the wake of a Jan. 29 Commerce Dept. report on gross domestic product that showed the economy streaking through the final quarter of 1998 at a blowout 5.6% annual rate, more and more forecasters are betting on a year of 3%-to-4% growth. "We're in the midst of the greatest business expansion in U.S. history," declares Allen L. Sinai, CEO of Primark Decision Economics Inc. "And there's no end in sight."

What's propelling the expansion? Consumer spending continues to sizzle: January sales of cars and trucks were almost double analyst predictions. And retailers are seeing surprising demand, too. "We had planned for sales to be flat in January, but they were up 4.3%--and the first few days of February are looking good, too," says Joseph R. Ettore, CEO of Ames Department Stores Inc. in Rocky Hill, Conn., the nation's fourth-largest discount retailer.

But the real surprise is the continuing growth in capital investment. Last summer, economists were seeing signs of a capital-spending slowdown. Now, Corporate America is betting its capital budget that the expansion will continue. In particular, companies are plowing money into technology to improve efficiency. In the fourth quarter, capital spending rose an astounding 21%. And once the rebound from General Motors Corp.'s strike is figured in, that hike is still more than double expectations. "One of the biggest surprises of this amazing economy is the continued substitution of capital for labor," says David A. Wyss, chief economist for Standard & Poor's DRI.

"HUGE MOMENTUM." There's more to come. Although corporate earnings and cash flow have been sluggish, new orders for capital goods jumped 7% in December. And while total capital spending probably won't approach 1998's spectacular 17.5% increase, it should match the 11% average annual growth rate for the 1990s. That was the strongest capital investment cycle in 50 years. Notes Bruce Steinberg, chief economist of Merrill Lynch & Co., who himself was much more bearish in early December: "There's huge momentum going into '99."

Nowhere is the momentum stronger than in high tech, where capital spending rose a stunning 32% in 1998 and has averaged 19% a year since 1991, according to Steinberg. Companies are looking to technology to boost efficiency. That's the best profit insurance in an economy where global competition is keeping prices down and a 4.3% unemployment rate is putting upward pressure on wages.

Meanwhile, the ever-expanding Web and the explosive growth of electronic commerce continue to spur enormous investment in the telecommunications industry. Ameritech CEO Richard C. Notebaert says carriers will keep buying switches, routers, and other equipment to meet the growing demands of an online economy.

The high-tech investment boom will be key to sustaining rapid growth without driving up prices from higher wages. That is, of course, if productivity gains continue. The signs so far are encouraging. The 1990s' investment boom has raised the nation's long-term productivity growth rate to 2% or more, double the rate in the 1970s and 1980s. Together with a labor-force growth rate of 1.1%, the higher productivity means the economy can grow 3% a year or more without rekindling inflation. "It's a once- or twice-in-a-century development," says David M. Jones, chief economist at Aubrey G. Lanston & Co., a New York bond trader.

The continuing growth in overall capital spending is all the more remarkable considering the state of traditional manufacturing. Factories have taken a double hit from Asia: Ailing economies there are buying fewer U.S. products while flooding the country with cheap imports. But even manufacturing is starting to show new signs of life. The National Association of Purchasing Management reported on Feb. 1 that its monthly index of manufacturing activity jumped four points in January, to 49.5, just shy of the 50 benchmark that signals increased output. The NAPM also said that export orders in January rose to the highest level in 13 months.

"Even the industrial sector may not be as bad as we thought," says Merrill Lynch's Steinberg. One reason is that multinationals are at last seeing a firming up of sales in emerging markets. That has companies such as Eastman Kodak Co. sounding bullish. The company "is as strong as we've ever been going into the beginning of the year," says President Daniel A. Carp.

STOCK PULLBACK? So are all the signals that made economists cautious last fall gone? Not really. Charles L. Hill, research director of First Call Corp., points out that profits are not growing nearly as quickly as stock market valuations. In the first quarter, the analysts polled by First Call figure that earnings of the S&P 500 companies will come in around 5% above year-earlier levels, and the second quarter doesn't look much better. "We just had a year of good GDP and lousy corporate earnings," says Hill. "This is our outlook for the first half."

That raises a concern that was prevalent last fall: the possibility of a pullback in the stock market. Economists including Federal Reserve Chairman Alan Greenspan worry that a second consecutive year of anemic profits could finally rein in the bulls, curbing both capital spending and consumer spending. Janet L. Yellen, head of President Clinton's Council of Economic Advisers, frets that even a leveling off of stock prices could have a chilling effect on the economy. "I think you would see a slowdown in consumption," she says. "And with capacity utilization not being very high, you could see a slowdown in investment spending."

For now, many execs only see the silver lining on the economic horizon. Alfred M. Zeien, CEO of Gillette Co., which took a beating in Asia, expects dramatic gains in 1999. Although the company reported a weak 4% earnings increase for the fourth quarter, Zeien predicts "a return to 15% to 20% earnings-per-share growth" by the second half of this year. And Ames's Ettore shrugs off a buying slowdown if Wall Street swoons--so long as wages keep outpacing inflation: "We cater to the working-class customer, who is not as affected by a stock market crash."

Such corporate confidence augurs well for a continuation of the capital investment boom. With consumers feeling just as upbeat these days, the U.S. economy looks poised to prove the pessimists wrong yet again.