Comments: John Lonski
Chief Economist, Moody's Investors Service
How do you expect the coming recovery to shape up, especially in terms of its strength and the sectors that will lead and lag behind? How have you factored in the uncertainties surrounding terrorist activity and the war?
The forthcoming recovery should be livelier than the aftermath of the 1990-1991 recession, but will fall considerably short of the +4% growth that was common to the latter part of the 1990s. An overseas conflict can abet the recovery by boosting government spending. However, sharply higher energy prices would be damaging. My forecast assumes, perhaps heroically, that the perceived threat of domestic terrorism will gradually subside.
The profits outlook is a crucial element in the recovery. What is your outlook for profits, and what factors will shape the profits recovery? Do your profit expectations square with those of investors?
In terms of pretax profits before changes in inventory valuation and adjusted for the possible misstatement of actual depreciation, the year-to-year drop of corporate earnings probably bottomed in Q3 2001 at --22%. This measure of profits may not grow year-to-year until Q2 2002. By 2002's second half, this measure of pretax profits could average a year-over-year gain of +15%, but off of the very low base of 2001's second half. Not until 2003 might this indicator of profitability return to its peak of 2000's third quarter. Aggregate demand will give direction to profitability. Moreover, today's extraordinarily low rates of capacity utilization, recent cost reduction efforts, and declining interest expense should amplify the response of profitability to any rejuvenation of business sales. Thus, investors should be careful not to extrapolate too much good news from what could be surprisingly steep annual advances by profitability during the latter part of 2002.
Consumers will likely play a major role in the strength of the recovery. In the face of low savings, heavy debts, and sharply reduced wealth, how much can we expect households to contribute economic growth next year? And can we expect any contribution from housing?
Do not overlook the stimulatory power of lower borrowing costs. Applications for mortgage refinancings recently reached heights that topped late-1998's record by 26%. Remember that 1998's surge by mortgage refis helped to trigger 1999's stronger-than-expected showing by consumer spending. For 2001-to-date, applications for mortgage refinancings have advanced by +517% year-over-year -- more than doubling 1998's scintillating gain of +232% annually. Against the backdrop of below-trend mortgage yields and a modest improvement in economic activity, home sales should do fairly well during early 2002.. In the context of a still soft economy, November's upswing by mortgage applications for the purchase of a home was encouraging. As far as giving direction to consumer spending, labor market conditions will outweigh low savings, heavy debt and less wealth. If initial state unemployment claims decline for a second straight month in December, then the underlying pace of consumer spending ought to improve during Q1 2002.
Copyright 2001, Bloomberg L.P.
