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MAY 9, 2005
U.S.: Businesses Won't Slip On The Oil Slick Costlier energy unnerves households, but capital spending will help growth During the first quarter, when the price of a barrel of oil spiked from $43 to $57, a spring slowdown in consumer spending seemed a good bet. And indeed, the jump in the cost of a gallon of gasoline, from an average of $1.75 to $2.15, was big enough to trigger some weakness in retail sales and consumer confidence. However, it's important to recognize that Corporate America is holding up quite well under the weight of costlier energy. It's a fact that glum investors, depressed by new worries over the economy, seem to be overlooking. But this development is important because the business sector is in good enough shape to carry the economy while consumers take a breather. Concern for the outlook centers around the double whammy of oil and uncertainty about future hikes in interest rates to be taken by the Federal Reserve. And analysts were startled by the Apr. 27 news that durable-goods orders fell 2.8% in March, including a large drop in capital-goods orders. But those data are notoriously volatile from month to month and run counter to almost all of the latest survey data. Other readings of the business sector show more resilience. Deep into April, new claims for unemployment insurance remain very low, implying no turn for the worse in the job markets. And regional surveys done by several Federal Reserve district banks reflect a generally upbeat pace of activity among companies. The same is true for a national survey done by the National Association for Business Economics. Plus, outside of autos, business inventories look lean in relation to sales, suggesting no unhealthy backup of stockpiles that could scuttle future output. WHY ARE COMPANIES holding up so well? First of all, given the general improvement in pricing power, many businesses are deflecting the impact of costlier energy by passing along the higher costs. That's especially true in many business-to-business transactions. Through March, producer prices for semi-finished goods, excluding energy and food, were up 7.6% from a year ago. This time last year, they were rising at a 3% yearly rate. Second, despite past Fed tightening, corporate interest rates are still attractive enough so as not to crimp borrowing. Yields on medium-grade 10-year corporate bonds are lower now than they were when the Fed began to lift short-term rates last June. The yearly growth rate for commercial and industrial bank loans is accelerating. And, of course, companies have a river of cash flowing in.  At the same time, Corporate America has largely recovered from its vast array of jitters of recent years. Business optimism is up, as executives have come to believe that the expansion is self-sustaining, and companies know from last year's experience that $50 oil and $2 gasoline will not permanently damage prospects for demand. Also, the steep slumps in capital investment and hiring during and after the recession have created some pent-up demand for new equipment and workers now that overall demand has picked up.One crucial indicator to watch in coming months is the trend in new orders for capital goods excluding aircraft. This trend is a key gauge of business confidence, since it represents future financial commitments by companies. Although these core orders dropped a sharp 4.7% in March, including a sag in machinery orders, the three-month average remains in an uptrend. However, should April orders post another sizable slump, more weakness could imply that firms are pulling back amid energy-related uncertainty. THE LATEST INDUSTRY SURVEY by the National Association for Business Economics offers some hope. The sounding from 103 respondents through Apr. 11 shows a "robust" outlook for capital spending and a second consecutive quarterly improvement in current employment conditions. The hiring outlook for the next six months shows further improvement as well. The April reports from the Philadelphia, Richmond, and New York Federal Reserves generally corroborate the optimism about the future. In particular, the Philly Fed's future capital-spending index increased for the third month in a row to the highest reading since 2000. And a heavy percentage of companies say they are adding to capacity, not just replacing worn-out equipment. To a great extent, businesses will make their future decisions based on consumer behavior. But even here, where the oil shock hurts the most, the effects will most likely be temporary. That's because, compared with this time last year, the household sector is being supported by stronger job markets and improving income growth. A key finding in the NABE's survey was that wages and salaries among the companies surveyed rose sharply in the first quarter. The association's wages index, which measures the net percentage of respondents reporting rising wages, hit its highest level in five years. Moreover, for the first time in four years, no respondents reported falling wages. Other broader measures suggest that the health of the labor markets continues to improve even with the runup in oil and gas prices. Well into April, new claims for unemployment benefits continue to run at levels that historically have been consistent with monthly payroll gains of about 200,000. The Bureau of Labor Statistics will report on the April labor markets on May 6. ALL THIS IS NOT TO SAY households are pleased with having to cough up $50 to fill their gas tanks. In fact, that appears to be the biggest factor in the recent dip in consumer confidence. The Conference Board's index fell for the third consecutive month in April, to 97.7. That's down from the recent high of 105.1 in January, but above the year-ago level. At the same time, though, households' assessments of the labor markets have not changed very much in recent months. Better job and income growth, along with mortgage rates back below 6% are supporting housing. Despite the sudden drop in March housing starts, which appears to be more related to bad weather than a bad economy, March sales of existing single-family homes rose 1.2% to a 6 million annual rate, and purchases of new homes jumped 12.2% to a record 1.4 million rate.  Given the recent, less ebullient trends in mortgage applications and the latest survey of builders, those sales results likely exaggerate the strength in housing. Nevertheless, still-strong demand to buy a home -- most consumers' biggest financial commitment -- suggests that households remain confident in their financial future.And just like last year, oil prices seem very likely to fall later in 2005 rather than rise. That's because world growth is shaping up to be a notch slower this year compared with last, and because oil and gasoline inventories are currently at adequate levels. But even if energy prices stay high, the U.S. economy will most likely prove -- for the second year in a row -- that it is strong enough to withstand $50 oil. And even if consumers get a bit winded from the load, Corporate America most likely will be there to help shoulder it.  By James C. Cooper & Kathleen Madigan
BW MALL
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