Slowdown? What Slowdown?
By Michael Englund
To the extent that the factory-led inventory correction and associated "income effect" has been restraining U.S. spending growth, the household and business spending data for the first two months of the year suggest that the "demand side" of the economy is putting up a good fight.
The most recent round of evidence was seen in the vehicle sales figures for February, which suggest that strength in the January spending figures was extended for another month. The strong data make it likely that any recession scenario will take on a "W" shape, as opposed to the widely feared "U," while the "V" shaped slowdown remains the alternative possibility.
The February vehicle data revealed a 2% gain in sales following the surprisingly strong 11% January gain. Indeed, the pace of sales reached 17.4 million units, which would have been considered record strength had it occurred at any time prior to late 1999, when an explosive surge in the economy temporarily drove sales to historic peaks.
The rise is even more puzzling on the back of hefty gains in vehicle prices over the past three months that have boosted the chain price index for consumption and the vehicle component of the consumer price index (CPI). These gains seem to be part of the reason that sales slowed so sharply in December, as lack of pricing power by the Big Three automakers and evaporating profit margins prompted a vehicle inventory liquidation.
This surprising strength in the February vehicle sales figures could cause retail sales to post a respectable 0.4% gain in February -- following a 0.7% January gain -- and the household spending data overall seem to support a 3% growth pace for "real" consumption in the first quarter. Of course, this certainly marks a slowdown from the 5.3% annual gain seen in both 1999 and 2000, but this increase is still remarkably strong if the dreaded "U" shaped recession is believed to be unfolding.
The unexpectedly robust sales figures are occurring alongside surprisingly strong data from the construction industry. This sector should post 4%-7% real growth in the first quarter given strength in both the construction spending figures and housing starts. The equipment spending data are also proving surprisingly resilient despite sharp downward revisions in the revenue projections of many equipment producers. As it stands, "real" spending on equipment and software should post only a modest 2% pace of contraction in the first quarter following the 3.5% rate of decline in the fourth quarter of 2000, and the sector appears poised for a 4% growth clip in 2000's second quarter.
The strength in spending early in the first quarter may reflect the strong seasonal pattern developing in the IRS refund data, alongside the reverse shift of individual tax payments toward the April due date and away from the other months of the year. The result is what seems to be a growing tendency for sales to outpace expectations in the first quarter and fall short of forecasts in the second quarter, as was clearly seen last year.
By most projections, refunds are again running ahead of schedule, while April tax payments should prove enormous given the available data on capital gains distributions from mutual funds.
And this explanation underlies our notion that a "dubya" shaped slowdown is a substantial risk. If sales indeed outpace expectations again in February, the risk is in place that the pattern reflects a tax distortion that will be quickly reversed in April and May.
Englund is Chief Market Economist for Standard & Poor's