U.S.: A Quirk Here, A Quirk There, And 1999 Came In Like A Lion
The Commerce Dept.'s news that the economy grew at a stunning 5.6% annual rate last quarter turned a lot of heads, especially those of many economists who are looking for a 1999 slowdown. That quarterly pace was the fastest in 2 1/2 years, and it suggested strong momentum heading into the new year.
To be sure, the economy is in its best shape in decades. Even with widespread global weakness in 1998, real gross domestic product grew nearly 4% for the second year in a row, with both inflation and unemployment at the lowest levels in a generation. Despite earlier fears, the U.S. economy appears to have thrived on the turmoil outside its borders. Yes, exports declined, but cheaper imports have lifted U.S. buying power. And the global financial meltdown has only increased the attractiveness of U.S. assets.
But before you get too excited about last quarter's growth rate, take a close look at the GDP data. While growth was fundamentally solid, it was clearly exaggerated by a host of special factors, including a rebound from the strike at General Motors Corp. and generous sales incentives by car dealers. Also, unseasonably mild weather boosted construction, and a surge in aircraft exports and other quirks caused a spike in the export data.
It's a good bet that a reversal of those influences will result in a much weaker growth rate this quarter, similar to the swing from 5.5% to 1.8% between the first and second quarters of 1998, when first-quarter growth was inflated by the unusually warm winter caused by El Nino. As then, an average of the fourth and first quarters will likely give a truer reading of the economy's underlying pace.
BY FAR, THE BIGGEST special factor last quarter was the end of the GM strike, which added 2.1 percentage points to the quarter's overall growth rate (chart). Commerce said that, excluding auto buying and additions to inventories, real GDP would have grown 3.5%.
Clearly, consumers' love of the automobile boosted yearend consumer spending. Fourth-quarter outlays grew at a 4.4% annual rate, but vehicle purchases soared 69%, accounting for about a third of the quarter's gain. The advance capped a 1998 spending spree, unlike any since 1983. In fact, households, whose spending makes up two-thirds of the economy, accounted for 85% of last year's real GDP growth. In the first quarter, though, vehicle sales are unlikely to rise at all. January sales were strong, but still below the 16.3-million average pace in the fourth quarter.
The strike distortion also affected equipment investment. On the surface, business outlays for machinery and high-tech gear jumped 21%, but that followed a 1% drop in the strike-affected third quarter, which was the first quarterly dip in seven years. The swing is illustrated in the data on investment in transportation equipment, which plunged 33% in the third quarter and then soared 65% in the fourth, the largest quarterly swing in that sector in 27 years.
The fact is, equipment investment is slowing. Outlays rose at a 9.4% annual rate in the second half after growth at a 26.3% pace in the first half. Even high-tech spending grew more slowly in the second half than it did in the first half. Companies are undoubtedly paring their capital budgets in the face of past rapid capacity growth, costlier financing, and softer profits.
PROFITS ARE ESPECIALLY CRITICAL to the 1999 outlook, not only for capital spending but for the overall economy because of the way they will affect both hiring and the stock market. In particular, households are relying increasingly on market gains to fuel spending and home buying (chart). Commerce data show that operating profits through the third quarter were below their year-ago levels, and early company reports on the fourth quarter suggest a small gain that is nowhere near what would typically be expected in an economy growing this strongly.
In addition to the GM strike, another key distortion in the GDP data was the unusually mild weather in November and part of December that boosted both residential and nonresidential construction. A return to normal weather this quarter means that, after the government's seasonal adjustment of the data, construction could well be a drag on first-quarter growth.
Certainly, housing is sturdy, buoyed by lower mortgage rates and stock market gains, but probably not as robust as the fourth-quarter's 10.1% advance in residential construction suggests. New single-family homes sold at an annual rate of 978,000 in December, after a record 1.02 million rate in November. The weather's impact was clearest in business construction, which posted a 5.5% gain last quarter, even though contract values have plunged 19% from their May peak.
THE FINAL ANOMALY in the GDP data is exports. Commerce says that shipments overseas suddenly jumped at a 19% annual rate last quarter, the largest hike in two years. That followed three quarterly declines, even though the world outside the U.S. is probably in worse shape than it was at the start of 1998.
The GM strike explains some of the surge. Vehicle exports leaped 72% last quarter, after sinking 33% in the third quarter. Also, a jump in volatile aircraft shipments pushed up the export gain. By themselves, aircraft typically account for about one-fourth of the quarterly ups and downs in overall export growth.
For 1999, new weakness in Latin America, the destination for 21% of U.S. exports, will cut foreign demand. Slower growth in Britain and the euro zone, which take 22%, will be another drag. And Asia, about 22%, will not offer much help either.
Despite the apparent export exaggeration, though, foreign shipments may well be stabilizing after their sharp drop in the first three quarters of the year. That would explain why manufacturing activity appears to have firmed up in January. The nation's purchasing managers reported that their January index of industrial activity rose from 45.3% in December to 49.5%, the highest level since last June. However, the index remains below the 50% mark, meaning that factory activity is still declining, and the January increase was up from December's eight-year low.
The most encouraging part of the purchasers' report was a second straight rise in the index of export orders (chart). That suggests that the worst of the drag from the Asian crisis, which led to most of the factory sector's 1998 weakness, may be ending.
If that's true, 1999 started off with some relief for 1998's weakest sector. But as was true last year, the outlook will be determined by what happens to domestic, not foreign, demand. The good news: The fourth-quarter data show that domestic demand was firm heading into the new year--but maybe not as robust as the top-line number would suggest.