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U.S.: It Was The Best Of Times, It Was The Best Of Times


Business Outlook: U.S. Economy

U.S.: It Was the Best of Times, It Was the Best of Times

As other sectors weaken, consumer spending should fuel the expansion

If you want to know the story on American consumers, don't expect A Tale of Two Cities. It was the best of times--The End. Just look around. A record number of people are working. Incomes are growing more than twice as fast as inflation. With the Dow Jones industrial average at 10,000, stock wealth has doubled in less than four years. Credit is cheap and available. No wonder consumer confidence is soaring.

None of this seems likely to change anytime soon, but if you must have something to grouse about, consider this: Not all sectors in the economy are doing as well as consumers. In fact, U.S. growth is becoming lopsided. Last year, consumer spending generated 3.3 percentage points of the economy's 3.9% growth. With the expansion increasingly dependent on consumers, any weakening in the supports to their spending could put the economy at risk.

The most susceptible support might be the stock market. Equity prices are dependent on earnings expectations, but corporate profits have been a disappointment. The Commerce Dept. reported on Mar. 31 that fourth-quarter profits adjusted for inventory changes and depreciation fell to $821.7 billion, and they were flat compared to year-ago levels (chart), even though the economy expanded by 4%.

In addition, companies are making less money from each unit of output. Profit margins fell last quarter despite economic growth of 6%. Earnings jitters are a big reason for the market's recent volatility. So far, though, consumers have shrugged off any market slide and just continue to spend.

OUTSIDE OF CONSUMER SPENDING, the three key areas to watch are foreign trade, housing, and business investment. After narrowing late last year, the trade deficit is widening again, and trade probably subtracted greatly from first-quarter economic growth. Housing may well be topping out, based on three straight monthly declines in new-home sales. And last year's second-half slowdown in capital spending appears to be continuing, given that both factory shipments of capital goods and production of business equipment through February are well below their fourth-quarter levels.

However, none of those sectors alone can control the economy as effectively as does the consumer sector, which accounts for two-thirds of real gross domestic product. For example, to generate an annual rate of growth of 1% in real GDP in one quarter, consumer spending by itself has to grow at a mere 1.4% annual rate. But capital spending alone has to increase by almost 8%, and housing has to soar by 24%.

That explains why the outlook for strong growth is so dependent on households maintaining a frenzied spending pace. And so far, consumers show no sign of buckling under the task, since their fundamentals remain supportive (chart). In particular, labor-market conditions appear as solid as ever. First-time claims for jobless benefits through Mar. 20 have remained below 300,000 per week since last January. The level of new claims has not been that low in any eight-week period in the last 25 years. Typically, if labor markets are loosening up in any big way, the shift will show up first in the claims data. And the volume of help-wanted ads in January and February was greater than in any other two-month period in nine years.

Also, very favorable financial conditions in the form of equity gains and low interest rates enable shoppers to splurge on new cars, bigger homes, and the latest high-tech gadgets. And the Federal Reserve appears content to keep money and credit flowing freely.

AS WIDELY EXPECTED, the Fed kept interest rates steady at its Mar. 30 policy meeting, and it gave no sign that it had shifted its bias for future policy decisions. In a recent switch, the Fed said that it now will announce any major shift in its thinking, even if it holds rates steady. Before this year, this so-called intermeeting policy bias had been available only after a lag of several weeks.

Some policymakers appear willing to allow continued strong growth until clear signs of a pickup in inflation emerge, unlike past preemptive strategies. As yet, supertight job markets have not generated serious wage acceleration, and economic problems abroad have kept U.S. inflation at only a 1.6% yearly rate in February.

Consumers are counting on a mix of strong job markets, low inflation, and solid business growth to continue through the rest of the year. The Conference Board's March index of consumer confidence rose for the fifth month in a row to 133.9, from 133.1 in February.

Confidence fell sharply last fall amid financial-market turmoil, but the index is now only four points below its three-decade high hit last June. Households were more upbeat in March than in February about both the current climate and expected conditions six months from now. Moreover, an all-time low 11.8% of consumers described jobs as "hard to get."

ECONOMIC OPTIMISM has been a substantial support to the housing boom. Home sales have slipped recently, but given U.S. population trends, they are coming off unsustainably high levels. After 1998's boom year, it is not surprising that housing sales and construction are likely to ease a bit in 1999. New single-family home sales fell 2% in February, to an annual rate of 881,000 (chart). Existing home sales also fell in February, dipping a small 0.4% to a 5.02 million rate.

Housing has been boosted by strong income growth, wealth gains from the stock market, and extremely low mortgage rates. But ultimately, homebuilding depends on the number of new households formed. And according to Standard & Poor's DRI, for the past few years new housing and mobile homes have outpaced the number of new households. That's even true when taking into account homes destroyed or demolished.

Demographics suggest that the number of new projects will start to fall. Already, the National Association of Home Builders says its members report a slowdown in buyer traffic and home sales. In addition, mortgage applications to buy a home are down 11% so far in the first quarter from the fourth quarter of 1998.

But given the healthy outlook for consumer fundamentals, housing is unlikely to drop sharply. Moreover, the outlook for home-related spending is still upbeat. Sales of furniture, appliances, and electronics, as well as remodeling projects, will probably increase this year and contribute to economic growth.

With growth more tilted toward consumers, the stock market becomes an increasingly important player in the outlook. Consumers are now so wired into Wall Street's ups and downs that the vulnerability of the market--and corporate profits--has become a new downside risk for the economy. But until the market turns, the best of times for consumers should roll on.BY JAMES C. COOPER & KATHLEEN MADIGANReturn to top


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