U.S.: Rough Pavement Now, but Not Down the Road
The mixed bag of economic data in recent weeks, while difficult to sort out, makes one clear point: The stutter-step recovery is stumbling once again this quarter. Compared with the third quarter's solid growth rate, which appears to have been higher than the Commerce Dept.'s first estimate of 3.1%, growth this quarter is struggling to make it into the plus column.
But the present is not prelude. Nothing in the numbers suggests the current quarter's weakness will carry over into the first quarter. It's just the opposite. This quarter's "soft patch," as Federal Reserve Chairman Alan Greenspan puts it, is a temporary downdraft from a host of one-shot problems, including labor disruptions at West Coast ports, a backtracking in car sales after an incentive-driven surge, and the summer slump in stock prices, which have since rallied. The uncertainty of war worries is also a big negative.
Fourth-quarter growth, in terms of real gross domestic product, will look disappointing, mainly because the downdraft hit in September and October. That creates some depressing math for the fourth-quarter GDP data, since many measures of demand and factory output are starting this quarter at very low levels compared with their third-quarter averages. Even if the monthly data for November and December look good, a weak GDP showing is already baked in the cake.
However, remember that solid fundamentals under consumer spending and firmer supports under business outlays assured that third-quarter growth would bounce back after slumping to 1.3% in the second quarter. Now, looking to the first quarter, those fundamentals are getting stronger: Confidence is rebounding. Labor markets are stabilizing (chart). Profits are picking up. And the Fed has taken out some recovery insurance with its aggressive cut in interest rates on Nov. 6, which was aimed at reducing uncertainty.
REPORTS FROM THE BUSINESS SECTOR are showing the effects of the summer's events. Manufacturing has been hit especially hard. Industrial production fell a steep 0.8% in October, the third decline in a row and the largest since the economy was in recession last year. But the numbers need to be read carefully. About half of the monthly output loss reflected falling auto production, which was depressed by parts shortages resulting from the port shutdowns on the West Coast from Sept. 29 to Oct. 9.
More important, indicators of demand, including factory orders and consumer spending on items other than autos, have not fallen off commensurately with output. And producer prices at the crude and intermediate stages of production are rising, another sign of firmer demand. This suggests factory activity will rebound in coming months.
Even so, one disturbing item in the output data was a second straight drop in the production of business machinery, down 1.5% in September and 2% in October (chart). The stock market plunge and war worries undoubtedly led to the tabling of some spending plans.
Still, these recession-size drops came suddenly after four months of modest improvement, suggesting other factors, including the dock situation, were at work. Indeed, through September, the trends in both capital-goods orders and shipments have held up. And the output of high-tech gear has increased every month so far this year. It's up nearly 15% from a year ago.
The port troubles are also skewing the GDP math for foreign trade. Dockworkers began a work slowdown in September, causing imports and exports to fall, and the trade deficit narrowed to $38 billion from $38.3 billion in August. The October gap is likely to shrink again, as the full impact of the port-related distortions reaches the data. But ships are now being serviced, so imports and exports will look stronger in November and beyond. To the extent that imports outpace exports, trade could be a drag on this quarter's GDP growth.
WHILE THE SUPPLY SIDE of the economy is signaling weakness this quarter, the demand side, especially in the consumer sector, suggests that momentum is building, which should carry the economy upward in 2003.
Consumer spending may not look too resilient, given the flat performance of retail sales in October. But that reflected the plunge in vehicle sales after auto makers removed the summer's generous financing deals. That falloff is why real consumer spending will be extremely weak this quarter, compared with its 4.2% annual rate increase in the third quarter.
Excluding cars, however, October retail sales jumped a larger-than-expected 0.7%, proving that households have not thrown in the towel (chart). The gains were broad-based, including a 4% jump in apparel sales and a 1.4% gain in nonstore retailers, mostly catalog and Internet retailers.
Consumers are continuing to shop because incomes are still growing well above the pace of inflation. Consumer prices rose 0.3% in October, or 2% over the past year. That rate is below the 3% yearly gain in hourly pay last month. Consumer buying power is also getting a boost in November, since gasoline prices are falling again, as prices of crude oil have declined more than $4 per barrel since the end of September.
IN ADDITION, the University of Michigan's index of consumer sentiment bounced back in late October, indicating households may not be as worried about job prospects or their stock portfolios. The declines in unemployment claims suggest the job markets have stabilized, and the latest survey from Manpower Inc. shows that companies plan to increase hiring in the first quarter. Plus, from Oct. 9 until Nov. 19, the stock market was up 16%. Those positive trends in incomes, labor markets, and wealth are evidence that consumer fundamentals are still very solid.
Despite the consistent gains in consumer spending, though, businesses have been cautious in stocking their inventories. Business inventories increased 0.5% in September, the biggest rise in almost two years, but that may reflect businesses stocking up on imports before the dock troubles boiled over. Much of the gain reflected recent ups and downs in auto inventories. Given the solid gains by nonauto retailers in October, inventories remain very low relative to sales. With little merchandise on hand, businesses will have to reorder soon--another reason to expect production to pick up in the first quarter.
A split between spending and output trends is nothing new, but it's crucial to remember that the dichotomy always resolves itself in one way: Barring a drastic change in fundamentals, as demand marches along, it will eventually carry production along with it. So while the economy is teetering this quarter, it will right itself by the first quarter, and the ride will be a whole lot smoother then.
By James C. Cooper & Kathleen Madigan