Comments: Diane C. Swonk
Chief Economist/Director of Economic Research, Bank One Corporation
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 recovery will be robust, but much more familiar and "old" than new, with gains in government spending and the return of dual trade and federal budget deficits shadowing the recovery.
Key factors driving the recovery will be a rebuilding in inventories, relatively low energy prices, the pipeline on monetary easing, which is substantial, and some fiscal stimulus. Also, we still have some considerable momentum to tap from the recent surge in home buying, as it tends to fuel spending for six months to a year as home owners remodel and furnish the homes they just bought.
Investment will and trade will remain the primary drags on growth, especially at the start of the year. Once investment does come back, however, it will not be the push on overall growth that we saw during the bubbling 1990s. We will be settling into a more normalized growth path for investment that is consistent with profits. Moreover, the kind of investment we see will at least initially be more in reaction to 9/11 than productivity enhancing investments in the inter/intranet. The collapse of the twin towers at the WTC made the need to decentralize and shore up back office operations, esepically in terms of protecting the information flows of a firm. It also heightened the need and desire to invest more in security and diversify telecom providers.
Again, the sense is that at least for a time, our economy will look more old than new as we make it through the transistion to an economy at risk for additional terrorism and War.
I am assuming that additional terrorist attacks are likely, and the War on Terrorism will be a long term event. This means that interruptions to business activity will become more common and costly as we must treat every accident and disaster as a potential terrorist event. With that said, the ability of those events to disrupt commerce as they did on 9/11 have been greatly diminished. We have already lost that side of our innocence, and as a result, can't lose it again.
Separately, the UK and Israel have adapted to terrorism and managed to expand. Why can't the most flexible and adapatable economy we have seen of its size in history be able to do the same. The capacity of humans to adapt to heightened stress in war torn parts of the world has been humbling, and should shed light on our abilty to adjust in the U.S.
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?
I am expecting profits to rebound fairly sharply next year, I part because comparison to this year are easy. Also the recovery will help, and finally energy prices, which took a major toll on profits last year, have reversed. With that said, I think we will see a catch up in profits, but the potential for profits over the longer term may be at least partially compromised by the compulsary spending firms must now do to hedge against terrorism, and the temporary hit those investments as a nation take on productivity growth.
Separately, there is an enormous amount of liquidity in terms of monetary stimulus in the pipeline, which in a low inflation environment should show up as inflated asset prices. I am very concerned that the Fed may not have an effective exit strategy to its recent round of easing, and as a result, be forced to deal with another round of financial asset bubbles in the years to come.
Bottom line: The upside in equities is significant, which markets are realizing, but those gains will exceed underlying fundamentals. This is not a return to the glory bull run of the 90s, and investors should not be too greedy this time around.
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 remain a remarkably resilient and strong part of the U.S. economy. Not only will aggregate income rise once employment picks up, but a reliquifying of consumer balance sheets through mortgage refinacing suggests consumers will be able to take advantage of those gains and buy again.
In terms of housing, the outlook is much more mixed. We had record home sales in a recession (total unique), it would seem overly ambitious to expect sales to lead the recovery from here. The good news is that we still have a good six months to a year to ride on the recent boom in housing to buoy spending.
In terms of the wealth issue, it seems clear that financial markets will be more kind than they were, and at the end of the day, it's the equity held in housing that matters to most households anyways. I do not expect a major correction in home prices outside of a few key bubble markets (New York, San Francisco, and Chicago) over the next year, which means consumers will still be able to tap that wealth to keep spending going for some time to come.
Copyright 2001, Bloomberg L.P.
