Now That's a Bit More Like It
It doesn't feel much like a recovery, does it? Despite the economy's solid 3% growth rate over the past year, unemployment, at 6%, is higher than it was a year ago. Businesses can't raise prices. The stock market is down year-to-date. And consumers, company executives, and investors have little faith in the future. Will 2003 be any different?
Yes, but don't expect the patient to start doing handsprings. The fractures from the stock market bust and the recession have yet to mend fully, and lingering uncertainties over terrorism and war with Iraq raise unanswerable questions about the future. Nevertheless, the economy will gain strength as the year progresses. "The coming year will feel much more like a recovery, with more consistent and more broadly based gains in economic activity," says Lynn Reaser of Bank of America Capital Management LLC in St. Louis.
That's the general view of the 66 business economists in BusinessWeek's 2003 Economic Forecast Survey. On average, the forecasters look for the economy to grow at about a 3% pace in the first half, with a pickup to about 3.5% in the second. Given that much of the growth will come from productivity, the rise won't be fast enough to push the unemployment rate any lower than 5.7%. But the growth rate will be sufficiently solid to keep inflation at about 2.2% and boost corporate profits by 9.7% (table, page 72).
Of course, the great imponderable--Iraq--could throw anyone's forecast for a loop. Most economists are betting on a quick and successful military outcome that brings a regime change. "This would give confidence and the financial markets a lift, bring down oil prices, and boost growth in the U.S. and global economies," says Peter Hooper of Deutsche Bank Securities Inc. But what if it goes badly? "The biggest unknown is unintended consequences," says Gail Fosler of the Conference Board. Those could include more terrorist strikes in the U.S., a disruption of the flow of oil, or wider instability in the Middle East.
Assuming the best-case Iraq scenario, the forecasters at BusinessWeek are a notch more optimistic about growth than the consensus. Why? First, exceptionally stimulative monetary and fiscal policy and the strongest productivity gains in three decades will buoy demand by helping to lift company profits and household buying power. Second, prices of goods in the early stages of production are already accelerating, suggesting that pricing power is likely to firm up. Third, and most important, as the year progresses, stronger demand and profits will spur businesses to hire more workers and shell out more for capital projects. Weakness in those two areas is what has so far prevented this recovery from feeling like the real thing.
That will change in 2003, when Corporate America begins to shoulder more of the load of getting the economy moving. Businesses have pared down excess capacity and inventories and are adjusting to the new realities of higher risk and of increased corporate accountability. As a result, "one aspect of the expansion in 2003 will be its switch from consumer-led to business-led," says Richard J. DeKaser of National City Corp. in Cleveland.
The key to this shift is an improving profits outlook. Clearly, industries such as telecommunications and airlines will hold back overall earnings, and many companies will have to pony up more for pension funds and health-care costs. However, David H. Resler of Nomura Securities International Inc. makes an essential point: "Due to strong productivity growth, unit labor costs are falling faster than prices, so profitability has improved despite a lack of pricing power." Maury Harris at UBS Warburg notes that this pattern parallels the early 1960s, a period when companies did very well with essentially no pricing power. The real benefit will come in 2003, when top-line revenue will pick up.
FINDING THE MONEY
Don't look for another investment boom, but do expect a gradual acceleration in the demand for new equipment and software that began in 2002. On average, the economists think equipment spending will rise 7.7% in 2003, more than twice the gain expected for 2002. Outlays for offices and factories will lag behind equipment because of high vacancy rates and low capacity utilization. Outside of telecom, however, businesses have made great strides in cutting their excesses. And as growing demand lifts operating rates in 2003, new capital projects will look attractive.
Finding the money won't be a problem. Corporate cash flow is up $112 billion during the past 1 1/2 years, thanks to new tax allowances for depreciation enacted in March. Further business-side tax cuts are a sure bet from the Bush Administration. Plus, financing is exceptionally cheap: The bond market is increasingly liquid, and the spreads between corporate bonds and riskless Treasury issues are narrowing, a sign of better credit quality. Banks remain picky, but fewer have tightened their lending standards over the past year.
At the same time, consumers will not fade away, although their 2003 spending will not match the strong 3.7% pace of the past year. The factors that boosted spending--zero-rate financing for cars, tax cuts, and cashouts from a record volume of home refinancing--will be gone, and households will be saving more because of lost stock market wealth. "That said, the 94% of the labor force that is gainfully employed is seeing rising real wages, which will be sufficient to sustain a moderate pace of consumer spending," says Michael P. Carey of Credit Lyonnais. Aftertax household income is up 3% from a year ago.
Consumer spending elsewhere in the world will be a lot weaker, however, implying only moderate global growth (table, page 70). Despite the European Central Bank's latest interest-rate cut, real rates in the euro zone remain much higher than in the U.S., and the region faces fiscal belt-tightening in 2003, especially in Germany. Japan will continue to struggle with deflation and the negative impacts from bank reform. The rest of Asia has performed well, and the outlook there depends mainly on the U.S., which will be getting enormous support from the Federal Reserve.
Now that the Fed has achieved price stability, which is every central banker's Holy Grail, it can keep policy stimulative for an unusually long time in an effort to insure against deflation and get the economy moving faster. The Fed will wait for stronger job growth before lifting interest rates toward a level that will foster continued price stability in 2004 and beyond. "Mr. Greenspan will want the recovery to have deep roots before he pours even a small dose of weed-killer on it," says Ian Shepherdson of High Frequency Economics.
The consensus of economists is that the first Fed hike will come in the second half. Until then, lower interest rates--the economy's Miracle-Gro--plus the ebbing of uncertainty will allow the recovery not only to put down deeper roots but to flower as well.
By James C. Cooper and Kathleen Madigan