Fatter Profits -- And Job Growth -- Will Send The Recovery Into High Gear
To hear economic forecasters tell it, the trip from 2003 to 2004 will be like going to sleep in Kansas and waking up in Oz. And it won't be a dream.
After two years of a tepid, hit-or-miss recovery that offered no assurance of better times ahead, all signs now point to a year of strong, well-balanced growth that will generate a lasting upturn. Better balance is the key: between spending gains by businesses and consumers, between rising profits and household incomes, between productivity increases and job growth. Simply put: "Everyone wins," says David W. Berson at Fannie Mae (FNM ).
One big reason is that in 2004 the benefits of the economy's long-run trend of faster productivity growth will shine through. Even as demand sputtered over the past three years of recession and mock recovery, productivity gains were lifting profit margins and the real wages of workers who kept their jobs. Now, amid stronger and more widely based demand, every addition to revenue will create even more profits. And with payrolls rising, each new worker will generate even more purchasing power. "This is the virtuous cycle," says Gail Fosler at the Conference Board Inc.
The business economists in BusinessWeek's survey, on average, expect the economy to grow 4.1% in 2004. That's fast enough to spur enough job growth to cut the jobless rate to 5.6% by yearend from its peak of 6.4%. They expect almost no change in inflation, which will be 1.9% for the year. They also look for the Federal Reserve to be patient in lifting interest rates, most likely not until midyear.
The forecasters are quite confident in their upbeat outlook. Two-thirds expect growth of 4% or better, including BW's Business Outlook editors' forecast of 4.4%. The lowest projection is 2.9%, which only a year ago was close to the consensus expectation for 2003. "With monetary and fiscal policy as aggressive as they have been in history, and with both household and business confidence on the rise, everything is in place for a robust economy with broad-based growth," says Joel L. Naroff of Naroff Economic Advisors.
It's hard to disagree. Strong profits are fueling a rebound in capital spending. New hiring and stock market gains are lifting household incomes, wealth, and confidence. Even the depressed manufacturing sector is stirring to life. Accelerating growth abroad, especially in Asia, and depreciation in the dollar are boosting exports, overseas profits, and U.S. competitiveness -- particularly in Europe, where the dollar has slipped the most. Cash-strapped state and local governments will be winners, too, as stronger growth lifts tax revenues. The capture of Saddam Hussein also may bolster confidence by removing some uncertainty over Iraq and improving stability in the region.
The biggest difference between 2003 and 2004 is that overall demand will not be as dependent on consumer spending and housing. Consumer buying will moderate as the stimulus from tax cuts and cheaper mortgages wane. But at the same time, "we expect the main growth engine to come from business investment and production," says Gene Huang at FedEx Corp. (FDX ). The combination of stronger demand and the investment bust of the past three years has resulted in pent-up demand for new equipment and insufficient inventories. "Businesses are starting to feel the need to expand in order to take advantage of new opportunities," says Gary Thayer at A.G. Edwards Inc. (AGE ). Outlays for tech gear are already matching the growth rates of the late-'90s boom as companies strive to boost productivity.
But don't expect productivity to repeat its recent surge of 5% over the past year. "Productivity gains will slow, but only from their present elevated levels," says Nariman Behravesh at Global Insight Inc. The good news: If productivity slows to 2% to 3% in the coming year, an economy growing at 4% would be able to generate job growth of 1% to 2%, equivalent to job gains of about 100,000 to 200,000 per month. "Job growth of just over 1%, combined with wage growth near 3%, will give consumers enough spending power to keep them a solid force for economic growth," says Stuart Hoffman at PNC Financial Services Group Inc. (PNC ).
The bright outlook isn't just an American story. Thanks to the dual thrust from the U.S. and China, the global backdrop looks the best in years. "China has jump-started growth throughout Asia and is stimulating exports from all industrialized countries," says Robert Gay at Commerzbank Securities. The U.S. is playing a smaller role as the world's growth engine. Chinese-driven strength in Asia is helping Japan pull out of its abyss, though its growth will continue to be limited by slow progress in restoring the health of its banking sector. The euro zone is also starting to turn up, but its recovery will be constrained by relatively stringent monetary and fiscal policies, by the euro's rise, and by slow progress on labor, pension, and regulatory reforms.
Despite expectations of solid economic growth, forecasters say that, amid so much slack, in terms of unused labor, equipment, and buildings, inflation will be a no-show, allowing the Federal Reserve considerable leeway to keep interest rates low. Nevertheless, the current 1% federal funds rate is far too low to be consistent with the Fed's long-run goal of price stability. At some point, as short-term rates start to inch up, bond yields will rise with them.
"We expect 2004 to be a difficult year for the bond market," says John Ryding at Bear, Stearns & Co. (BSC ). In that regard, the Fed is damned-if-it-does, damned-if-it-doesn't. When the Fed begins to move, long-term rates will rise. If the market thinks the Fed is waiting too long to hike, yields will jump anyway out of worries over inflation. "My fear is that the Fed will be too slow to lift rates," says Ian Shepherdson at High Frequency Economics Ltd. Like nearly all economists, Shepherdson isn't concerned about inflation in 2004, but the danger would come later on.
Is there a Wicked Witch to foil next year's rosy outlook? Fears of terrorism or a Middle East crisis that could cause oil prices to spike are common. But there are new worries. "My biggest concern remains the immense [U.S.] current-account deficit and the risk of a dramatic decline in the dollar," says Lynn Michaelis at Weyerhaeuser Co. (WY ). A sharp plunge in the dollar could bring a retreat in foreign capital so crucial to U.S. growth, along with higher inflation and interest rates. Mounting federal deficits also raise concerns about interest rates.
But that risk goes beyond 2004, and strong growth has a way of lessening other worries, including those over the dollar. For the coming year, forecasters see an economy ready to skip down a yellow brick road of rising demand, fatter profits, and solid job growth.
By James C. Cooper & Kathleen Madigan