A New Risk: CEO Gloom

Many top execs beg to differ with economists' recent cheer

To a growing chorus of economists, the signs of recovery couldn't be clearer: Manufacturing orders are rebounding strongly. Consumer spending remains buoyant. Unemployment slipped further in February. And tech spending has started to crawl out of a deep hole. Add it up, and gross domestic product is on track to grow a healthy 3% to 4% in the first half.

But that rosy view isn't shared by many in the corner office these days. CEOs around the country remain decidedly cautious, even downright gloomy, about the state of the U.S. economy. That's true of execs from electric utilities to commercial banks, but perhaps nowhere more so than in manufacturing. According to a survey of 90 corporate leaders released on Mar. 11 by the National Association of Manufacturers, three-quarters expect GDP to grow no faster than 2% during the first half of the year. "The good news is the downdraft is over," says William R. Timken Jr., chairman and CEO of Timken Co. (TKR ), a Canton (Ohio) maker of ball bearings and specialty steels. But, he adds, "the economists are getting ahead of reality."

For growth to be sustainable, corporations will need to loosen their purse strings in the coming year and expand capital spending and hiring. But in manufacturing, the capacity utilization rate is at about 73%, the lowest since 1983. So companies can handle a significant uptick in demand before they need to think about adding capacity. While there are signs companies may be starting to hike spending for technology that enhances productivity, it hardly looks like a boom. A Mar. 11 Merrill Lynch survey found that most chief information officers don't expect a surge in tech spending until 2003. The problem is, without a pickup in investment and hiring, warns John M. Youngdahl, senior economist at Goldman, Sachs & Co., "growth could downshift later this year or early next year."

Companies may find that too much pessimism could come back to bite them. A recent PricewaterhouseCoopers survey shows that 75% of 405 fast-growing companies polled found it even more difficult to forecast customer demand in 2002 than 2001. That is forcing them to stick tightly to conservative budgets, faster GDP growth or not. But if those spending plans aren't flexible, PricewaterhouseCoopers partner Paul Weaver notes, such caution could crimp sales growth if demand picks up.

CEOs have missed turns in the business cycle before. In the spring of 1980, a BusinessWeek survey of corporate execs found that most saw little sign of an imminent recession--even though one had already begun. In early 1991, economists, consumers, and executives alike remained in sync--everyone was pessimistic well past when the economy began to improve. Says Ken Goldstein, an economist at the Conference Board: "[CEOs] tend to be lagging indicators."

It's easy to see why top execs are edgy. For one thing, with much of the current rebound stemming from replenishing inventories, CEOs remain worried that once those stockpiles get back to normal, demand could dry up. Consider steel. While inventories held by distributors have been falling, demand for steel used in commercial construction "is still in the pits," says Daniel R. DiMicco, CEO of Nucor Corp. (NUE ) "We don't see anything right now that says there is even an intermediate recovery in the works."

That downbeat feeling exists even in robust industries. Appliance maker Maytag Corp. (MYG ) announced on Mar. 12 that sales for the first two months of 2002 were surprisingly strong due to inventory restocking by some dealers. It turns out dealers who had expected home sales to slow after Christmas needed to replenish their showrooms when that dropoff never materialized. But Maytag warned 2002's strong start would be a one-time boost. The company figures that once those inventories have been refilled, orders will slow again.

And profits? After last year, you would expect execs to be overjoyed by the prospect of a 17% earnings rise for the Standard & Poor's 500-stock index, the current Wall Street consensus, according to Thomson Financial/First Call. But they're not. Since earnings are coming back from extremely depressed levels, a 17% jump would only bring profits back to 1999 levels--hardly reason for cheer in executive suites.

And with CEOs taking a beating on Wall Street for overpromising on earnings, there's also little upside in getting out ahead of the recovery. Lingering anxiety about future terrorist attacks also makes some execs cautious. "There's this feeling that terrorism could interrupt things," says Tim Sheesley, corporate economist at Xcel Energy (XEL ), a large utility serving 12 states. "So [execs] are reluctant to move to expand."

Moreover, many companies are still wrestling with excess capacity. So while auto sales are holding up, Ford Motor Co. (F ) and Chrysler Group lost 2.3 points of market share to foreign rivals last year, and the slide continues. Both are shaving capacity by closing plants and idling workers. And while General Motors Corp. (GM ) is holding on to most of its share, a weak balance sheet has GM slicing costs, including an 11% cut in capital spending for 2002, to $7.1 billion.

If capital spending isn't surging ahead, at least the big cuts most industries endured last year appear to be coming to an end. While government figures for total business investment in equipment showed a decline of 4.8% in the fourth quarter of 2001, the pace had slowed considerably from the 15.4% decline in the second quarter. Chemical giant DuPont (DD ) expects capital spending in 2002 to be in line with 2001's $1.6 billion after several years of reductions.

Still, many companies are using their capital-spending budget to tiptoe back into productivity-boosting technology investments. James W. Keyes, CEO of retailer 7-Eleven Inc. (SE ), is upping capital outlays this year by over 40%, to just above $500 million. The hike will go mostly for information technology, including systems that tie the company directly to suppliers for better inventory management. Keyes says he became optimistic late last year, when lower energy prices left his customers with more discretionary income.

A few are starting to see the signs of an economic upswing that most CEOs are still waiting for. Daniel J. Warmenhoven, CEO of Network Appliance Inc. (NTAP ), a Sunnyvale (Calif.) maker of computer storage systems, says the economic upturn is part of the reason the company's sales for the fiscal fourth quarter, ending Apr. 26, will be up 2% to 5%, the first gain in four quarters. "I'm pretty confident the decline has stopped," he adds. "Companies have stopped the meat-ax approach to [technology] budgets."

Another potential boost: The stimulus bill passed by Congress on Mar. 8 gives companies an extra 30% first-year tax deduction for new equipment. Economists don't expect the credit to have a major impact on the economy. But it could help revive tech spending since the break is especially valuable for short-lived gear such as computers.

Capital spending isn't the only area where companies are holding off. Faster growth or not, few are ready to start cranking up hiring yet. Diesel engine maker Cummins Inc. (CUM ) has seen demand pick up for some of its smaller engines. But engines for big rigs are still in the dumps. And the company, which lost money last year, will post another loss in the first quarter, so hiring is still on hold. Alfred Hoffman Jr., CEO of residential homebuilder WCI Communities Inc. (WCI ) in Bonita Springs, Fla., has come to the same conclusion. Although sales and traffic levels have recovered from their post-September 11 dip, he's hesitant about removing a hiring freeze in place last fall. "We'll probably wait another month or two to get confident," says Hoffman.

Some pockets of hiring are heating up. As foreign carmakers grab share, they are expanding. Toyota Motor Corp. (TM ) is taking applications for 2,000 new jobs at its Indiana truck plant. And airlines such as United Airlines Inc. (UAL ), which are scrambling to adjust to the rebound in travel, have been adding flights and recalling furloughed workers.

Still, for the most part, companies will only start adding new employees when rising demand makes it absolutely necessary. That makes perfectly good business sense. Ditto for holding back on capital expenditures and staying cautious on profit projections. So until CEOs see solid signs of recovery in their own industries, they aren't likely to start spending freely again, rosy economic pronouncements or not.

By Amy Barrett in Philadelphia and Michael Arndt in Chicago, with Wendy Zellner in Dallas, Kathleen Kerwin in Detroit, and bureau reports

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