So far this year, it doesn't feel much like a recovery, does it? Where's the surge in orders? The profits? The jobs?
Yet economic growth has averaged 3% for the past three quarters, and third-quarter growth is shaping up to be about that pace as well. That's a far sight better than the 1.8% slog during the first three quarters of the weak 1991 recovery. But despite the faster pace, businesses are just as hesitant to invest in new equipment now as they were then, and the recovery remains just as jobless.
What's going on? The difference between 2002 and 1991 has to do with both psychology and economic fundamentals. First of all, pervasive uncertainty generated largely by noneconomic factors is clouding the future. The current climate of corporate scandals, the related plunge in the stock market, and threats of terrorism and war in Iraq are making corporations hesitant to plan ahead. Those factors are also undermining consumer confidence, and retailers are increasingly worried about sales in the second half.
Second, and more fundamentally, rapid productivity growth means the economy needs to run hotter than it did a decade ago in order to get payrolls growing at a significant clip and to pull the unemployment rate lower. Growth at 3% is close to the economy's new long-run trend, but that pace has generated little in the way of job growth, and the jobless rate remains stuck at close to 6%. The bottom line: It's going to take at least 4% growth to make this upturn feel like a recovery and offset some of the worries about the future.
THAT MAY TAKE A WHILE. However, after some troubling reports a few weeks ago that fueled fears of a second dip into recession, fresh data for July suggest the economy continues to move forward at a moderate clip (charts). Consumers, for instance, are still shelling out for new homes and cars, spurred on by low interest rates and good income growth. And businesses may not be nearly as glum as earlier reports had suggested, since durable-goods orders overcame a worrisome plunge in June and surged broadly in July.
The reversal, especially in the capital-equipment sector, puts a new light on third-quarter prospects for manufacturing and business spending, suggesting the summer weakness in activity may have been only fleeting. However, further corroboration of this notion must come from upcoming August reports from the nation's purchasing managers on Sept. 3 and from the Labor Dept.'s employment data on Sept. 6.
Even so, there's no denying the July numbers were impressive. Orders booked by durable-goods makers jumped 8.7% from June, when they dropped a steep 4.5%. Big gains in aircraft and autos led the advance, but even excluding the transportation sector, orders still rose a sturdy 3.9%, reversing June's 3.9% drop. Most important, core orders for capital goods, which exclude the volatile ups and downs in commercial aircraft and defense, leapt 8.1%, more than balancing out June's 6.3% plunge.
It was that June fall that first created worry over the second-half outlook for capital spending and the economy, because capital-goods orders are generally viewed as a proxy for business confidence. The July bounceback suggests that the earlier weakness was a reaction to the corporate scandals and their effect on stock prices. Now, investors are beginning to shake off the effects of Enron Corp., WorldCom Inc., and the rest, and companies may be focusing on better prospects for the second half.
FOR EXAMPLE, THE FACTORY DATA show that inventories of durable-goods manufacturers keep shrinking, even as shipments accelerate. Inventories fell 0.4% in July from June, while shipments jumped 3.1%. Over the past six months, stockpiles have shrunk at an annual rate of 6.6%, but shipments are up 4.2%.
As a result, the ratio of inventories to shipments has fallen to levels not seen since the boom year of 1999. The ratio is now below its downward-sloping trend for the past decade, which could mean inventories are slightly lower than most manufacturers would desire. If so, factories will need to lift production schedules soon.
Yet while business executives seem to be regaining their confidence, consumers appear to be losing some of theirs. The Conference Board's index of consumer confidence fell from 97.4 in July to 93.5 in August, the lowest reading since November, 2001. The indexes covering householders' assessments of the current economy and their expectations for six months down the road each fell in August. The Conference Board said the readings are consistent with a "continued, but slow, economic expansion."
But to a large extent, consumer worries are driven by the noneconomic clouds over the outlook, in addition to economic-related concerns such as job security and rising energy prices. Even though the jobless rate has stabilized, consumers perceive employment prospects as worsening, not improving (chart).
However, while consumers may tell pollsters they are concerned about the outlook, their actions indicate otherwise. Consumers continue to buy big-ticket items such as cars and homes, which require long-term financial commitments--and confidence in the future.
HOUSING, IN PARTICULAR, remains one of the most vibrant sectors of the economy. Existing home sales rose 4.5%, to an annual rate of 5.3 million in July, while new-home sales increased 6.7%, to a record annual clip of 1.02 million homes. Indeed, builders of new homes are on track to have their best year ever in 2002.
Clearly, low mortgage rates of just over 6% for a 30-year fixed loan are boosting demand, but consumers must also have some faith in their job prospects and income potential in order to take on a mortgage. That confidence is supported by the downtrend in jobless claims and rising aftertax incomes. In addition, many consumers now view housing as a better investment than stocks, which provides another boost to demand. But because housing never slowed during the recession, the sector has limited capacity to add to gross domestic product growth in the second half, given that mortgage rates appear to have bottomed out and homeownership is at a record high.
Moreover, further advances in real consumer spending will depend on job growth, which in turn will rely heavily on how businesses view the economy. That's why the durable-goods data were a good omen for consumers as much as for businesses in the second half.
So far, this lackluster recovery has been less than satisfying for investors, executives, and workers. Until job growth takes off and businesses begin to mark up their profit expectations and invest more, don't look for this recovery to provide the bounty of past rebounds.
By James C. Cooper & Kathleen Madigan
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Copyright 2002, by The McGraw-Hill Companies Inc. All rights reserved.
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