Business Outlook: The Budding Recovery Has Staying PowerJames C. Cooper
The worst U.S. recession since the 1930s appears to be over. The best sign: Real gross domestic product, the most comprehensive gauge of the economy's ups and downs, almost certainly hit bottom in the second quarter. Monthly data so far suggest a surprisingly strong advance this quarter with enough momentum to keep the upturn going in the fourth quarter. Still, many investors are skeptical. The improving outlook has succeeded only in setting off a hot debate: Is the recovery sustainable, or just a temporary bounce fueled by a few one-shot government programs?
The debate will not be settled anytime soon, but several underlying forces make a strong case that the upturn is durable. Already, spending by consumers and businesses, homebuilding, and manufacturing activity have begun the third quarter with much more oomph than expected, and many economists think annualized GDP growth in the 3%-4% range this quarter is a real possibility.
The key force at work is the sheer volume of fiscal and monetary policy. Its support of demand this year and next dwarfs any such effort in the downturns since World War II. To date, most of the fiscal stimulus has been tax-related, along with other income support. However, much of the stimulus from infrastructure spending and other government outlays is only now working its way into the economy. For example, since January the growth of public construction spending through July has accelerated to an 18.9% annual rate.
Plus, the Federal Reserve's support of the credit markets will continue to strengthen financial conditions, so crucial to growth, well into 2010. Housing will benefit greatly. Already, the housing component of GDP is set to add to growth this quarter for the first time in 3 1/2 years. Plus, with home prices bottoming out, prospects for mortgage-backed securities will improve, helping to further shore up housing while stanching the bleeding on bank balance sheets.
Prospects for business spending are also looking brighter, especially given the surprisingly strong performance of profits, which drive the expansion of outlays and hiring. In the second quarter, profits of nonfinancial corporations, based on the Commerce Dept.'s accounting, rose at a 19.3% annual rate from the first quarter—an especially solid performance for a quarter with falling GDP.
Profit margins also grew last quarter, a testament to the benefits of corporate cost-cutting and productivity gains. Nonfinancial companies are emerging from this recession with margins much higher than at the end of the last recession. With revenues set to pick up in the second half, further gains in profits are a sure bet.
Of course, consumers will be essential to a lasting recovery, and their help will require stronger labor markets. The plus here is that businesses have been extremely conservative in their spending and hiring, which puts them in a good position to gear up quickly as a recovery takes hold. Many are doing so, as the recent easing in job losses suggests. In fact, income growth, the key to any sustained increase in consumer spending, is already getting support from wages and salaries, which rose slightly in July for the first month in almost a year.
Finally, the upturn is global, with Asia, the Americas, and Europe all set to grow simultaneously. A synchronized recovery will boost the volume of world trade, especially to the benefit of U.S. exporters. Trade typically has been a drag on U.S. growth early in a recovery, as demand picks up in advance of other economies, boosting imports and widening the trade deficit. This time the trade gap is not likely to widen as rapidly, eliminating a potentially large hindrance to growth.
In the past, steep recessions have been followed by robust recoveries as was the case in the 1970s and 1980s. The current upturn seems to be starting out that way as businesses restock their exceptionally low inventories. But even if it doesn't maintain its initial burst, the strengthening supports under demand in all major sectors suggest this recovery has legs.