Commentary: Even Consumers Get the Blues

Ever since the economy hit the skids at the start of the year, optimists at the Federal Reserve and on Wall Street have been counting on the free-spending consumer to keep the U.S. out of recession and lead a recovery. Indeed, revised gross domestic product figures released on Aug. 29 showed that the economy was able to stay out of recession territory in the second quarter thanks mainly to consumer spending. And there have been reasons for further optimism: cheaper credit from the Fed and $40 billion in tax rebates from Uncle Sam.

Well, now that upbeat script may have to be rewritten. U.S. consumers are showing signs of strain. More and more workers are losing their jobs as companies pare payrolls to boost sagging profits. But it's not just the pink-slipped employees who are feeling the pinch. Even workers who haven't come under the ax could be in for rougher times because of slashed bonuses and higher health-care premiums. Add in a stock market that's in a funk and housing prices that may be peaking, and there's plenty of reason for concern.

In one worrying sign of a crack in the consumer monolith, the Conference Board reported on Aug. 28 that confidence fell for the second straight month in August. Indeed, the surprise drop came even as rebate checks were being mailed.

To be sure, the fall in confidence was small. And it was all concentrated in consumers' assessment of current economic conditions. When asked about the outlook six months from now, consumers remained more optimistic.

But the downdraft in sentiment is troubling. It means that the hoped-for pop from the rebate checks could be a lot smaller than the 1% boost in growth many economists had been banking on. In fact, an Aug. 10-12 Gallup poll found that only about 25% of those taxpayers who had received checks had spent the money.

What's more, consumer optimism about the future could prove misplaced. Layoff announcements are mounting--and will likely get worse before they get better. In the closing days of August, Deere (DE ), Honeywell (HON ), and Hughes Electronics (GMH ) all announced job cuts.

Companies are not apt to stop there. With profits under pressure, they will also cut back on bonuses and stock options. Ford Motor Co. (F ) said on Aug. 29 that it was eliminating bonuses for its top 6,000 managers. Last year, those payments totaled $442 million. When the smoke clears, Goldman, Sachs & Co. economist John Youngdahl thinks companies could slash such payments by $30 billion early next year, reducing compensation by 0.5%.

WHIPSAWED. Even as income stagnates, many workers are about to get socked with a big rise in their health-care costs. Because of rising drug prices and waning savings from managed care, health-care costs are expected to rise by 16% in 2002, the fastest rate of increase in more than 10 years, according to New York consultant Segal Co. With profits squeezed, many of those costs will be passed on to workers. Half of midsize companies surveyed in August by insurance-services firm Marsh Inc. said they intended to make workers pay a greater share of health-care costs.

Consumers are also getting whipsawed by the stock market, which has failed to rally despite Fed rate cuts. So far, rising home prices have offset some of the losses on Wall Street. But that source of strength may be ebbing. The National Association of Realtors said on Aug. 27 that the median house price rose at an annual rate of 5.2% in July, vs. 6.4% in the second quarter. And a further cooling-off is likely. Already, prices are falling in some of the hottest housing markets, such as Silicon Valley.

Add it all up, and it means the optimists at the Fed and on the Street may end up caught in their own version of a Samuel Beckett play--waiting for a full-scale recovery that never seems to arrive.

By Rich Miller & Laura Cohn

With Kathleen Kerwin in Detroit

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