The Economy: Why So Gloomy?

Despite rosy reports on jobs and strength in stock indexes, polls show that Americans are none too impressed

by Peter Coy

Do ordinary Americans know something about the U.S. economy that the experts don't? A perception gap has opened up lately between Wall Street and Main Street. Optimism about the economic outlook is still fairly strong among professional investors, market strategists, and economists, but there's increasing pessimism in the America where most people live and work.

And here's where perception could become reality. If Main Street is right, and it has been before, it could be bad news for the stock market, not to mention corporate profits and the general climate for business.

At the start of 2007, the market and the public seemed to be in sync: both optimistic. But since then, the stock market has marched generally higher (with a few downward jolts, of course) while public sentiment has faded. Robert Garcia, senior events producer for New York-based Job Expo, which puts on employment fairs, says he senses a lot of uncertainty among ordinary Americans. "There's a war. People are unsure about where that's going to lead us. The housing market's in a big slump and it's going lower."

Uncertainty About the Future

It's not so much that current conditions are bad. After all, the economy created 180,000 jobs in March, and the unemployment rate, at 4.4%, hasn't been lower since May, 2001 (see BusinessWeek.com, 4/6/07, "The Job Market Shows Strength"). The problem, says Garcia, is concern about what the future holds. "Things have picked up. The only thing we're seeing is uncertainty about the future."

That's a fairly recent change in sentiment: As recently as this January, a Bloomberg/Los Angeles Times poll found that 68% of the public thought the economy was doing well. But in its latest reading Apr. 5-9, that share had dropped to 57%. For what it's worth, the survey also found that 60% of Americans thought it was very or somewhat likely that there could be a recession in the next year, but that statistic is less meaningful because the question hasn't been asked regularly so it's hard to say if the figure is especially high.

Interestingly, on the Bloomberg/Los Angeles Times poll question about the current state of the economy, high-income families (those earning more than $100,000, who account for most investment dollars on Wall Street) showed the least slippage in sentiment, from 81% positive down to 76% positive.

Lower Rungs Most Vulnerable

Things were gloomier on the lower rungs of the ladder, though. Positive sentiment about the economy among people earning less than $40,000 dropped sharply, from 61% to 43%. Those lower-income families are the people who are most vulnerable to problems in the economy, such as the increase in gasoline prices of 60¢ per gallon since early February. The question is whether they are the canaries in the coal mine, giving an early warning of more general problems to come.

Wall Street has mostly shaken off the warning signs so far. In spite of a down day on Apr. 11, the stock market has been marching generally higher since its hiccup in late February. The Feb. 27 drop was sparked by a panicky sell-off in the Chinese stock market. In the weeks since, the Standard & Poor's 500-stock index has recovered to just 1% or so below its record high of nearly 1,460, which was set on Feb. 20. The decline on Apr. 11—when the S&P 500 dropped 9.52 points, to 1,438.87—seemed to be linked to the release of the Federal Open Market Committee's March meeting minutes, which showed increased concern about both slower growth and higher inflation.

Experts see the consumer confidence figures as a negative for the economic outlook, but not an extreme one. Keith Hembre, chief economist of Minneapolis-based First American Funds, which manages $100 billion in assets, says that consumer spending has been running somewhat stronger than one would expect from the modest readings for recent consumer surveys—including those of the University of Michigan, the Conference Board, and ABC News/Washington Post.

Big Chill on the Economy?

Hembre is expecting spending growth to slow in keeping with the greater pessimism. He's forecasting it to grow at an annual pace of about 2.5% for the remainder of 2007 after having increased at a 3.6% pace in 2006 and the first three months of 2007. That would be a big chill on the overall economy, since consumers account for close to 70% of gross domestic product.

But Hembre doesn't buy the idea that the economy is headed for a recession. In fact, he thinks the S&P 500 could hit 1,550 by the end of 2007, based on current earnings expectations and an expansion of the price-earnings multiple on the index from a little over 15 to around 17. Says Hembre: "Multiples are below where they should be in a low-inflation, low-rate world."

That's the bullish case. The bearish case is being expressed by a lot of Americans who spend more time thinking about the price of regular gasoline or a loaf of bread than price-earnings multiples.

Coy is BusinessWeek's Economics editor.