Traffic on the Road to Recovery
By Amey Stone
Economists have known for a while that the economy would slow this year from the blistering pace of the second half of 2003. After all, the 6.1% growth in gross domestic product in those six months was fueled by massive amounts of mortgage refinancing and by income tax cuts -- two sources of stimulus that have lost some of their oomph this year. The only question going into 2004 was, how much would growth slow?
In January, as fourth-quarter earnings surged, the bet was that the economic expansion would decelerate only slightly, to perhaps 4% to 5% GDP growth for 2004. But a recent spate of weaker-than-expected reports may be indicating that the economy has hit, if not a speed bump, at least those little warning washboards that tell you your car is straying onto the shoulder.
A serious dip in consumer confidence reported on Feb. 24 is the clearest recent indicator of this. In fact, for a while in late February it seemed that every economic number, from durable-goods orders to first-time unemployment claims and new construction to auto sales, was coming in just a little worse than anticipated.
OUT OF TOUCH?
"Consumers began the year on a high note, but their optimism has quickly given way to caution," wrote Lynn Franco, director of The Conference Board's Consumer Research Center, of last month's numbers. "Consumers remain disheartened with current economic conditions, and at the core of their disenchantment is the labor market."
True, that probably reflects disappointed expectations more than hardship. "There was a feeling after the third quarter last year and some of the early fourth-quarter numbers that the economy was really flying," says Milton Ezrati, senior economist and strategist at investment firm Lord Abbett & Co. "That was never in touch with reality. What we're getting here now is an expanding economy, but not one that is flying. And I think people are beginning to adjust to that from their former exuberance."
While economists started off the year betting on 5% GDP growth in the first quarter, it could come in at 4% or even a little lower, believes Greg Valliere, chief strategist of Schwab Washington Research Group. "I see the economy doing O.K., but leveling off for a while here before it gets a little better in the spring," he says.
Valliere thinks tax refunds will drive stronger growth in the second and third quarters. "Maybe we're splitting hairs, but you get the sense that until these refund checks kick in, we could have moderate [growth]," he says.
So far, March has brought some relief from the negative drumbeat. On Mar. 1, an index of manufacturing activity came in stronger than expected and hinted at hiring in factories. A Mar. 2 government report on consumer spending also remained strong, showing that even if consumers are less confident, they remain ready and willing to shop.
However, the willingness of businesses to spend -- and hire -- remains a wild card. In reporting fourth-quarter numbers, many chief executives were subdued in their outlooks. Cisco (CSCO ) CEO John Chambers noted that the businesses that buy his company's networking equipment are getting a bit more optimistic about the overall economy. But they remain "perhaps surprisingly" cautious about their own capital spending and hiring plans, he added.
Investors worried about the recovery's sustainability are hoping for strong job growth in the government's monthly payroll report, to be released on Friday, Mar. 5. Any rise in unemployment could be a serious disappointment (see BW Online, 2/29/04, "What Investors Want Now: Jobs").
Plenty of economists see recent signs of weakness as nothing more than a blip. Bad weather in January certainly played a role in subpar housing and retail numbers, points out Valliere. One reason Ezrati isn't as worried about slack durable-good orders is that it was "all centered in aircraft orders, which tend to be extremely lumpy. You get away from that, and the numbers continue to expand, showing that there's some growth in capital spending."
Indeed, Lincoln Anderson, chief investment officer at LPL Financial Services, a brokerage firm that serves independent investment advisers, calls the recent weakness "short-term fluctuations" in monthly data. "My concern levels for the economy are near all-time record lows," he says. "When you stand back a little bit, it looks to me like there's tremendous power driving this economy forward."
Over the course of 2004, Anderson thinks, continued low interest rates and stimulus from tax cuts will spur spending by both consumers and businesses -- and lead to more job growth. "I think it just takes a while to knock down all that skepticism," he adds. In the meantime, though, as recent weakness in the markets shows, investors are keeping an ear tuned for even the subtlest signs of trouble on the road ahead.
Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist