Execs Need to Follow Consumers' Lead
By Amey Stone
The economy is struggling mightily to stay afloat, aided mainly by optimistic consumers who continue to buy homes and new cars, travel and shop, typically borrowing heavily to fund their purchases. According to government figures released on Sept. 13, retail sales jumped 0.8% in August -- the third consecutive month of gains. Consumer credit rose 7.6% in July, to a record $1.7 trillion, driven by credit-card use and auto financing. Fueled by historically low interest rates, mortgage applications and refinancings are at all-time highs.
Contrast this behavior with that of businesses: Instead of borrowing and spending, corporate execs continue to focus almost exclusively on cutting costs and repairing their balance sheets. Imagine how robust the recovery would have been if businesses had behaved more like consumers for the past year?
It's high time for Corporate America to start doing so. Profits are perking up a bit in the third quarter, giving companies some breathing room on expense control. Meantime, signs are emerging that consumers are growing fatigued. On Sept. 13, the University of Michigan's survey showed that consumer confidence dipped for the fourth straight month (although it remained higher than it was in fall, 2001). Back-to-school sales this year were weaker than expected, perhaps as consumers poured money into their homes and cars, foregoing trips to the mall.
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What the economy needs is for businesses to pick up the baton from consumers and give the economy some underlying strength by investing in future growth. "Someone has to step up, and when someone finally does, everyone will follow -- and the economy will regain traction," says Mark Zandi, chief economist at Economy.com. "Business people are looking at each other and saying, 'Are you advertising? Are you hiring? Are you expanding?' So far the answer is no, and they aren't either."
Corporate spending remains moribund, especially in technology. A Sept. 9 survey by Goldman Sachs of corporate information technology buyers found that they continue to spend less than they've budgeted. Survey results predict a decline in overall tech spending of 1% in 2002 and a gain of only 2% to 3% in 2003 (ominously, Wall Street analysts still expect technology sales next year to increase by 9% year-over-year).
Economists say companies are reluctant to spend more when they can't raise prices and when future sales growth is uncertain. But this can become a self-fulfilling prophecy, warns Erick Maronak, research director at NewBridge Partners. If businesses won't invest in improving their products in the face of tepid demand, then demand will remain weak.
"A CONFIDENCE ISSUE."
Instead of investing, many leading companies have been quietly amassing mountains of cash. Microsoft probably has the biggest pile. Its June, 2002, balance sheet shows that it has $38.7 billion in cash and short-term investments, up from $31.6 billion the year before. As of June, 2002, General Motors had $19 billion in cash and short-term investments, Pfizer had $11.3 billion, and Intel had $10.3 billion.
Companies are also borrowing a lot less. According to the Federal Reserve, bank business loans are down by more than 7% from a year ago. (In contrast, consumer loans are up 4% over a year ago.) The monthly pace of investment-grade corporate-bond issuance averaged $57 billion a month in the first half of the year. But in the third quarter it's likely to fall to $31 billion, according to Moody's Investors Services estimates. This drop would come despite borrowing costs being at their lowest since the late 1960s.
"My feeling is that it's a confidence issue," says Lisa Black, portfolio manager of the TIAA-CREF Bond Plus Fund, of why the economy's rebound hasn't been stronger. "The feeling [among companies] is that they don't need that additional capacity, that demand may not materialize." Part of businesses' reluctance to borrow is that credit standards have tightened, but they're also facing pressure from Wall Street to reduce debt.
Recent declines in the stock market may be affecting the mood of corporate management, even though profits in the manufacturing sector rebounded nicely in the second quarter, the National Association of Manufacturers reported on Sept. 13. "Unfortunately, the recent uncertainty surrounding the stock market declines will likely hold down business investment to moderate growth for the remainder of the year," noted the group's president, Jerry Jasinowski. "Therefore, we're not likely to see a complete recovery in manufacturing profits until sometime in 2003."
As a result, companies aren't doing much in the way of hiring or handing out raises. On Sept. 12, a rise in first-time jobless claims indicated that unemployment, which dipped in August to 5.7% from July's 5.9%, was likely to rise again to just under 6% when September figures are released. "The consumer isn't going to ratchet up spending until they feel better about their jobs," says Trip Jones, a senior vice-president at Fulcrum Global Partners. "And corporations won't do anything until consumers start to spend more. We need something to break the cycle."
Businesses acting more like consumers would certainly do the trick. But it shouldn't be a matter of charity, because investors would revolt if corporate spending didn't make good business sense. "I wouldn't like to own shares of a company that was altruistic with its capital-spending strategy," says John Lonski, Moody's chief economist.
Nonetheless, with economic recovery under way, corporate profits improving, and borrowing costs at a 35-year-low, a few leading businesses would be well-served to step up spending now. Companies need to start spending in advance of new demand or risk being caught short when customers come back. The U.S. economy just needs a few trendsetters to get the ball rolling.
"People are looking at each other and waiting for someone to move," says Zandi. "Then a lot will follow. They almost have to." CEOs, start your engines.
Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column
Edited by Beth Belton