U.S.: The Winter Landscape Isn't As Bleak As It Looks
When the books are closed on 2002, the economy's growth pattern will look like the squiggles of an EKG, with spikes of 4% to 5% tucked between rates of 1% to 2%. The fourth quarter will be one of the year's low points, with growth struggling to come in at half the third quarter's 4% clip. But the patient remains healthy, and the reading is set to spike up again next quarter.
That much seems clear from some recent upbeat data. In October, consumer spending bested previous expectations, as did the level of new orders for capital goods. Homebuilding remains resilient. The industrial sector is still struggling but showing signs of recovering from its summer slump (chart). And in November, the stock market managed to hold on to its October gains, while a clear downtrend in new filings for unemployment benefits raises hopes that massive layoffs are a thing of the past and that businesses will start hiring again in coming months.
Nevertheless, while the economy heads into 2003 on a solid if unspectacular trend of about 3% growth, it will also begin the New Year much as it started 2002: dogged by uncertainty. Fear of the unknown, so palpable just after the September 11 terrorist attacks, has waned somewhat, as have the shocks of corporate scandals. But the question marks of a possible war in Iraq and how economic policy will play out in the new Republican-led Senate still weigh heavily on any assessment of the outlook.
Despite recent upbeat signs, households are dealing with the year's losses in the stock market, which is down about 20% year to date, and businesses are still coping with low utilization rates. However, the solid performance of key fundamentals, including productivity, real household income, and corporate profits, against a backdrop of stimulus from low interest rates and improving financial conditions, are giving the economy the momentum it needs to take real gross domestic product growth to a higher plane next year.
THE CHIEF GUIDE for the economy's strength in early 2003 will be--as it has been all year--consumer spending. That's why October's stronger-than-expected 0.2% increase in real outlays is so encouraging. Outside of the expected drop in car buying, consumer spending posted solid gains. Outlays for durable goods, which include cars, plunged 0.9%, but spending on nondurable items, such as food and clothing, rose 0.5%, the largest increase in nine months; and service purchases, about half of all spending, posted a 0.2% advance.
The problem for fourth-quarter economic growth is that household outlays--two-thirds of GDP--began the quarter in a deep hole. Car sales, which averaged an annual rate of 17.6 million in the third quarter due to generous sales incentives, fell to 15.3 million in October and picked up to 16 million in November. As a result, total consumer spending began the quarter 0.9% below its third-quarter level. Even with solid increases in November and December, consumer spending will post little growth this quarter, compared with the previous quarter.
The strong performance, however, of nonauto spending in October and upbeat reports on post-Thanksgiving sales, both at brick-and-mortar stores and on the Internet, suggest that consumers are still in a buying mood. Clearly, households have plenty going for them. In addition to the stock market rally, cash from record refinancing activity will fuel spending this quarter and next. Also, energy prices have declined.
Most important, net hiring gains since April have lifted the yearly growth rate in wages and salaries to 3% in October, from no growth earlier in the year (chart). After adjustments for inflation and taxes, real household income has grown at an annual rate of 3% during the past six months, while overall spending has risen only 1.9%. Consumers clearly have the ability to spend at a faster clip, and that stronger trend will reassert itself in coming months.
BUT CONSUMERS HAVE BEEN DOING their part throughout this recovery. The sticking point in the outlook is the unwillingness of business to spend on new equipment or facilities or to boost output enough that more workers are needed. The caught-in-the-headlights paralysis from the year's uncertainties is keeping many companies from moving forward, but recent data at least suggest that companies are no longer slashing production schedules or capital budgets as they were throughout 2001 or earlier this year.
The latest reports from the Institute for Supply Management (ISM) confirm that the service sector is expanding at a faster clip and that manufacturing has all but stopped deteriorating. The Business Activity Index for nonmanufacturers jumped from 53.1% in October to 57.4% in November, while the ISM's index for manufacturers edged up from 48.5% to 49.2%, just below the 50% mark, which divides contraction and expansion. Industries boosted production last month, and delivery times continued to lengthen, but the factory indexes covering new orders and exports weakened. One key reason that businesses are not showing more momentum, said the ISM, was the Iraq situation: "Members felt the uncertainty is a deterrent to business."
CAPITAL-GOODS ORDERS, long seen as a proxy for business confidence, also support the idea that businesses remain hesitant about the future. Orders for nondefense capital goods excluding aircraft jumped 5.5% in October, nearly wiping out the declines of the previous two months. But nonaircraft capital-goods orders, always a volatile series, have been especially bouncy this year. In general, the trend in orders has been decidedly flat in 2002 (chart).
Companies are holding off from buying much new equipment for several reasons. First, operating rates at many industrial companies are extremely low--U.S. factories, on average, are only using 73.5% of their capacity. So companies have little need to expand their facilities. Second, companies are waiting to see if the new Congress passes tax incentives on capital investments, which would make equipment buying cheaper, and if Washington extends credits for research and development.
Third, strong productivity is allowing companies to boost output without adding one lick of new machinery. The Labor Dept.'s revised data show output per hour worked in the third quarter grew at an annual rate of 5.1%, up from the original estimate of 4%, leading to growth of 5.6% over the past year--the strongest such pace in 30 years.
Mostly, though, businesses are still unconvinced that demand will remain strong enough to justify boosting their capital budgets and moving ahead with new projects. It will probably take solid, back-to-back quarterly gains in real GDP to persuade businesses to shake their paralysis and start spending and hiring. But don't expect to hear that tale this quarter. That's a 2003 story.
By James C. Cooper & Kathleen Madigan