| BUSINESSWEEK ONLINE : AUGUST 16, 1999 ISSUE | ||||||||
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| BUSINESS OUTLOOK
U.S.: Who Says the Iceman Cometh? Expect the economy to heat up again soon, despite a brief chill The surprise of 1999 has been the economy's strength, following the gloomy period last fall when almost all forecasters expected much slower growth this year. Now comes word that real gross domestic product posted an unusually modest gain of 2.3% last quarter, nearly half the first quarter's 4.3% pace and down sharply from the 6% surge in the final quarter of 1998. Is the long-awaited slowdown finally taking place? Don't bet on it. For one thing, mild winter weather exaggerated the strength in the data on construction and other weather-sensitive activity in the first quarter. A return to normal weather in the spring resulted in a sharp falloff in those sectors, which was more the result of vagaries in the government's seasonal-adjustment process than of a slump in real activity. Weather likely skewed some of the upcoming July data as well. The record heat across much of the country may have held down retail sales, outside of car buying, while sending utility output through the roof. More important to the second-half outlook, the GDP data show few signs that domestic demand is waning. The fundamentals of household spending remain as strong as ever. Consumer spending, by itself, has more than accounted for all of the economy's growth in the first half, offset partly by drags from a wider trade deficit and slower inventory growth. Business outlays for high-tech equipment continue to drive capital spending. Also, after a year of stagnation, exports show new signs of life. With demand likely to stay very strong, labor markets will continue to tighten. In fact, the second-quarter surge in employment costs suggests that last year's slowdown in pay and benefits may have run its course, although the big quarterly gain probably overstates the trend. ONE KEY BOOST to second-half growth is sure to come from more inventory building, which is separate from any precautionary stocking that companies will do because of Y2K computer worries (chart). Demand has been so strong that inventory growth in the second quarter was unsustainably low in an economy this strong. The restocking effort, in addition to stronger exports, will fuel the manufacturing rebound. Inventories grew by a mere $19.4 billion in the second quarter, half of the first-quarter increase and well below the $50 billion pace averaged in the second half of last year. During the past year, final sales of goods have grown twice as fast as inventories. To be sure, computerized systems have allowed companies to run leaner, but stockpiles are now so low that some companies may be unable to fill orders in a timely manner, thereby threatening the loss of sales. In June, factory inventories fell 0.1%, as shipments jumped 1%, pulling the inventory-sales ratio down to a record low of 1.31. Overall domestic demand last quarter grew 3.9%, down from the first quarter's blistering 6.8% pace. That slowdown is misleading, however. Consumer spending grew at a healthy 4% pace in the second quarter, but that followed the first quarter's 6.7% surge--the largest increase in more than a decade--which was aided by mild weather and by the stock market's strong rebound from its autumn tumult. The trend in consumer spending still shows growth of 5% from a year ago (chart), and car buying began the third quarter at a strong 17.1 million annual rate. Income growth alone is strong enough to support most of that 5% trend, and wealth gains will contribute much of the rest. Personal income rose 0.7% in June, and real disposable income is growing 3.4% per year. As long as job markets stay tight, income growth at that pace can be easily sustained in the second half. SO FAR, LABOR MARKETS show no sign of loosening up. Indeed, initial claims for unemployment benefits in the July 24 week matched an expansion low. Also, the second-quarter employment cost index--a reading of what companies pay out in hourly compensation, including wages and benefits--jumped 1.1% from the first quarter, the largest increase in eight years. That gain might not have been as big it looked, though. Keep in mind that the ECI in the first quarter rose only 0.4%, the slowest pace on record. The gyration mainly reflected a dearth of bonus payments in the finance industry in the first quarter, a result of the fourth-quarter turmoil on Wall Street. As Wall Street rebounded, second-quarter bonuses surged. During the past year, wages and benefits have grown 3.1%. That's up from 2.9% in the first quarter, but compensation growth hit an expansion peak of 3.6% in the third quarter of 1998. Labor costs are still growing only moderately, but the slowdown appears to have ended. Tight job markets mean that renewed acceleration may well be in store for the second half. MANUFACTURING IS THE SECTOR that is best situated to benefit from continued strength in demand, especially with inventories so low and with foreign demand accelerating. The National Association of Purchasing Management said that manufacturing continued to improve in July after last year's slowdown, although activity proceeded at a slower rate than in June. Still, two key indexes from the NAPM survey point to the firming trend in demand: More companies reported slower delivery times than at any time in more than 1 1/2 years (chart), and more purchasers reported rising prices of materials than in nearly two years. Taken together, those readings clearly show that markets for manufactured goods are tightening up, and that operating rates are likely to rise. The only slowdown candidates for the second half are housing and capital spending. Thirty-year fixed mortgage rates have broken through the 8% threshold that typically begins to dampen home demand. Already, the trend in mortgage applications to buy a home has taken a downturn. However, with other consumer fundamentals so solid, any sudden collapse in housing is unlikely, although the sector will not be contributing to second-half growth. Capital spending is likely to be a mixed story. Equipment outlays grew by a strong 15.3% last quarter. But most of that gain occurred in information technology, while spending in industrial machinery, transportation equipment, and other items is growing more slowly than it was a year ago. Also, spending to fix Y2K problems is likely to slow as well, as more companies finish their debugging process and hunker down to see what havoc Jan. 1 brings. Slower trends in capital spending and housing won't trigger the hoped-for soft landing, however. Consumers have to rein in their purchases further if the economy is to avoid the production constraints and worsening labor shortages that typically generate inflationary pressures. For now, though, households seem oblivious to that possible scenario. They're too busy shopping. BY JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS U.S.: Who Says the Iceman Cometh? CHART: Stockpiling Will Fuel Second-Half GDP CHART: The Wide Gap Between Incomes and Spending CHART: Companies Are Waiting Longer for Supplies INTERACT E-Mail to Business Week Online | |||
