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THE NEW YEAR'S BUNDLE OF JITTERSProfits will flatten out but growth should continue, albeit at a slower rate
For 1999, however, the headwinds are picking up. That's the word from the 55 economists in BUSINESS WEEK's Annual Outlook survey. In uncommon unity, forecasters from all around the country expect growth to slow, perhaps substantially. And while only a handful predict a recession, the ''R'' word is on almost everyone's mind. Economists believe that all of the risks to their forecasts are on the side of weaker, not stronger, growth. They are anxious over homegrown problems, such as sagging profits and a possible stock-market bubble, as well as global risks stretching from Brazil to Japan to Europe.
BUSINESS WEEK's Business Outlook editors expect the economy to grow at a subdued 1.7% pace in 1999, measured by growth in real gross domestic product. That rate is a shade below the 1.9% survey average (table), reflecting their belief that domestic demand, the linchpin of 1998 growth, will face formidable constraints in 1999. Also, they do not rule out the possibility of a recession in the event of another global financial shock, given that domestic demand will be far less capable of offsetting any damage. On the inflation front, the Business Outlook editors look for the consumer price index to rise a modest 1.9%, up from an expected 1.4% in 1998. Cheaper oil will help keep the rate low, but the broader impact of the trade-weighted dollar's 10% drop since August will halt the decline in import prices. And they expect the unemployment rate to rise to 5.2% by yearend, from an expected 4.5% at the end of 1998, as GDP growth slows to a rate below the economy's long-term trend of about 2 1/2%. EARNINGS GLOOM. Maureen Allyn at Scudder Kemper Investments Inc. sums up the feeling of most economic analysts: ''First of all, the economy's recent rate of growth is simply not sustainable. And second, companies are having more and more trouble making their profit numbers.'' Allyn and others note that shoppers are spending far more than they earn. Builders are putting up more houses than demographics justify. And businesses are adding production capacity faster than they need it. Profits are a major concern. Among those who project corporate earnings, the consensus is that reported earnings per share will be virtually flat in 1999 (chart)--a far more pessimistic view than that of Wall Street analysts, who expect a 17% gain (page 94). The profit story, most economists believe, will be a continuation of the one in 1998. Labor costs will not be offset by productivity, and pricing will remain weak because of excess capacity in the U.S. and abroad. ''It will be difficult to expect any material increase in corporate profits until the differential between wages and prices narrows appreciably, or until global demand picks up,'' says Anthony Chan at Banc One Investment Advisors in Columbus, Ohio. Sagging profits will hurt in several ways. They will dampen capital spending and job growth as companies are forced to cut costs. ''Reversals in profit growth, the likes of which we have seen during the past year, have always been followed by a major economic slowdown,'' warns James W. Coons of Columbus-based Huntington National Bank. The hope is that profits make a comeback later in the year. Rosanne M. Cahn at Credit Suisse First Boston notes that 1998 earnings shortfalls were mainly in industries with weak pricing power, such as oil and other commodities. ''Stabilization of prices in these markets in 1999 should stabilize profits in those industries and let strength elsewhere show through,'' she says. By the end of 1999, though, the damage to capital spending from weaker profits will already be done. Add in slower growth in the U.S. and abroad, tighter credit conditions, and falling capacity utilization, and it's easy to see why capital spending is the most vulnerable sector of domestic demand. Business construction already is falling. And when you exclude the still rapidly growing high-tech component of equipment spending, you have a much worse picture for ''plain-vanilla'' equipment, says Kenneth Mayland at KeyCorp in Cleveland. His advice to the Midwest: ''Brace yourselves.'' THE GLOBAL EFFECT. Moreover, U.S. companies won't get much help from foreign demand. ''The soft global economy is--and will remain--the most serious constraint on the U.S. economy through 1999,'' says Mark Zandi at Regional Financial Associates in West Chester, Pa. Shaky global financial markets already have proved that they can bring down U.S. markets, and the effects will linger. Global events in 1998 caused a broad reassessment of risk among investors and lenders in the credit markets, and that resulted in less-available and costlier credit for many U.S. businesses, especially for those with less-than-sterling ratings. Moreover, banks are tightening their lending standards for most businesses. Foreign weakness also adds to Corporate America's earnings woes. Deflationary winds from abroad are sapping U.S. pricing power, while falling exports push manufacturing ever closer to an outright recession. Factory output has all but stopped growing, and manufacturers have shed more than a quarter-million jobs since April. For 1999, the news for manufacturing only gets worse. Economists expect a further widening in the already vast U.S. trade deficit--although not as rapidly as in 1998. The problem, says Robert A. Brusca of Nikko Securities Co., is that imports grow about 2.5% for every 1% of domestic growth. So foreign growth must be much stronger than growth in the U.S., just to keep the deficit from widening. But world GDP growth will be no better than that of the U.S. (chart). The result: ''We do not see a bottoming in the trade deficit until the next recession,'' says Brusca. With foreign trade and capital spending under heavy pressure, economists look to consumers to save the day--and they just might. In 1998, consumer spending surged 5%, though incomes rose just 3%. ''The difference in 1999 will be that spending will grow in line with income, not in excess of it,'' says Daniel E. Laufenberg of American Express Financial Advisors. But with job markets set to loosen only gradually, and with low inflation boosting buying power, consumers are unlikely to stop spending. And even if outlays grow at only half their 1998 pace, that rate will be enough to keep the economy moving. But even the consumer sector is not risk-free. Because of the soaring stock market and the resulting additions to wealth, consumers are spending all of their income. The household savings rate actually fell below zero in 1998 for the first time since the Depression. That dearth of traditional savings leaves households vulnerable to a fall in stock prices. While the Fed's rate cuts have calmed the markets, they also have boosted stock values. William C. Dudley of Goldman, Sachs & Co. points out: ''Fed easing might sustain consumer spending in 1999, but only at the expense of an even greater savings imbalance.'' That could be setting up a tougher adjustment later. If consumers pack it in, a recession is all but certain. BRAZILIAN TREMORS. That's a big risk, but it's not the only one. ''Collapsing confidence in Japan, further commodity-price pressures on Latin America, a possible rise in protectionism, and a Brazilian devaluation are all possible catalysts for a recession,'' cautions Richard C. Berner at Mellon Bank Corp. Brazil is the top worry. ''In the next six months, Brazil must roll over some $90 billion in debt,'' says former Fed Governor Lawrence B. Lindsey. The recent International Monetary Fund package will guarantee only about half that much, and the country already is backpedaling on needed fiscal reform. Japan is another basket case. It is at least making policy moves to lift itself out of a severe recession and to address its debt-ridden banks. But a recent survey shows Japanese businesses are the most downbeat in 4 1/2 years. And even in Europe, growth is expected to slow. High unemployment will keep a lid on domestic demand and, amid sagging world growth, an export-led recovery is not an option. Elsewhere, the global collapse in commodity prices has left commodity-producing nations with little hope for growth. Weak oil prices are putting Mexico at particular risk. Despite the caveats, most forecasters believe that the economy will muddle through 1999. After all, monetary policy is supportive, and the federal budget surplus leaves room for a tax cut, needed or not. With a little luck, this expansion, which began in March, 1991, will fly right along into the next millennium, becoming the longest business upturn in the postwar era. But keep that seat belt buckled.
By James C. Cooper and Kathleen Madigan in New York RELATED ITEMS
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GROWTH AT 1.7 PERCENT. Still, the betting is that modest growth will prevail, bolstered by steady, if slower, consumer spending growth and by recent interest-rate cuts in the U.S. and Europe. Also, most economists expect further Federal Reserve easing, especially if the ride gets bumpy.
Updated Dec. 17, 1998 by bwwebmaster
Copyright 1998, by The McGraw-Hill Companies Inc. All rights reserved.
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