Comments: Steven Wood
Chief Economist, FinancialOxygen, Inc.
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 relatively anemic because the recession will be fairly short and shallow. The 2 sectors that will lead the recovery will be consumers and inventories. Consumer spending will be supported by additional fiscal policy stimulus, low energy prices, substantial mortgage refinancing, and low interest rates. An improving equity market and continued (albeit slower) gains in housing prices will lift wealth effects. However, the absence of any significant pent-up demand and relatively higher debt levels, suggest that consumer spending will not return to the boom years of the late 1990s and early 2000. The other sector that will help boost economic output will be inventories, which have fallen sharply this year. As inventory decumulation eases and eventually reverses, production and employment will improve, lift overall economic growth. This shift could be substantial, adding 1 to 2 percentage points to growth in 2002.
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?
We expect profits to recovery but for the rebound to be relatively anemic. However, because of the sharp declines over the past year, the year-on-year comparisons will look much better. Although economic activity is forecast to accelerate, inflation will retreat further, restraining gains in nominal income. Ample excess capacity‹both domestically and internationally‹and intense competitive pressures will continue to restrain pricing power. Although labor compensation will retreat it will not be sufficient to generate any significant acceleration in profits. Based on the sharp improvement in equity markets in recent weeks, investors perceptions of the profits recovery is much more robust than ours.
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?
Consumer spending should expand 2.5% to 3.0% in 2002, growing in line with gains in real disposable income. Although nominal wage gains will slow further in response to labor market weakening, the worse of the job losses will be over by early next year. As the recovery gathers strength, employment will pick up and work hours will lengthen. This will help sustain nominal income growth. Additionally, further tax cuts (both those already scheduled as will as new tax incentives) will boost disposable income. Inflation will slow next year in response to this year's economic weakness. This will help to augment real disposable income.
Moreover, equity markets and home prices are expected to increase over the year, adding to household wealth. Although equity wealth effects are likely to be relatively small, housing wealth effects will be more supportive of consumer spending.
Not only will high debt burdens restrain spending but a modest increase in energy prices and higher interest rates will have adverse impacts as well. Higher energy prices will sap some purchasing power while higher interest rates will foreclose additional refinancing activity.
The housing market is unlikely to provide any significant contribution in the next year. Housing remains at very high levels and no substantial contraction is anticipated over the next several months. Without a more significant downturn in housing, no significant rebound is projected from already elevated levels.
Copyright 2001, Bloomberg L.P.
