Comments: Joel L. Naroff
President, Naroff Economic Advisors
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 unknown, of course, is future terror attacks. This forecast assumes that they are not devastating and are accepted without any major dislocations. If that is the case, the recovery is expected to be explosive for the following reasons: 1) Government spending at all levels will be up by nearly double-digit levels for as much as two quarters and will be strong throughout the year. This will include not just direct defense and security spending but other indirect expenses; 2) low interest rates which have reduced interest costs, tax changes and expected additional so-called "stimulus" tax cuts have added dramatically to discretionary income and as consumer confidence rebounds (see terror assumptions above) consumption should surge; 3) the inventory adjustment process is nearly over and while significant inventory builds are not expected, the drag should disappear; 4) the investment collapse will continue but at a more moderate pace. All of these factors should lead to a robust recovery. The rebound should be broad-based and it is expected that by summer, even the hospitality sector will be sharing in the expansion. That may take time, but when it does, that should be the final indication that the economy is back up and running. The one major uncertainty is trade. Exports may continue to slow but will the borders be more closed than they had been? If so, the trade deficit may narrow even more than forecast during the first part of the year. It is expected to start widening again by the fourth quarter.
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?
Weak profits (declines) are expected for the fourth quarter and possibly first quarter, but they should pick-up smartly by the spring. Thus, investment should be weak for the first half of the year, restraining growth somewhat. But that should begin to change during the second half of the year. As businesses see demand grow, only those industries with massive excess capacity will lag. Nevertheless, spending on equipment and software will have to reaccelerate during the year, if only to remain world-competitive.
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?
Consumers will lead the way. Debt may be high but low interest rates have dramatically reduced debt burdens and added significantly to discretionary income. The negative wealth effect will slow demand for some items, but the 0% financing showed that consumers still will buy a product, no matter the expense, if the deals are good. The recent strength in vehicle and home purchases makes it clear that households are already trying desperately to get back to business as usual. With mortgage rates slowly rising during 2002, that could initially add to demand, at least during the spring and summer, as the usual thinking of "buy before rates get too high" takes hold. Still, mortgage rates are expected to remain relatively low for the entire year and that should help sustain the housing market. If the equity markets continue to firm, as expected, we could easily see another fine year for housing.
Copyright 2001, Bloomberg L.P.
