The Consumer on the Cusp


By Margaret Popper So far, waiting for the U.S. recession is turning out to be like waiting for that big storm that was supposed to shut down the East Coast at the end of February. Lots of scary warnings -- not much snow. The first quarter came and went, and while it's unlikely that the gross domestic product numbers will show much growth, it seems almost as unlikely that they'll show actual contraction.

Like meteorologists, economists and strategists are constantly looking for signs that will tell them what's going to happen next. In this economy, the most important barometer is the American consumer. Without the consumer out there buying stuff, the economy would hardly have weathered the precipitous pullback in capital spending.

What's difficult to gauge is whether consumer psychology can hold out against the gloom. There are several factors helping to bolster it -- among them lower interest rates, a strong housing market, and a (comparatively) strong job market. But there are still plenty of winds that could upset the consumer's apple cart and tip the economy into recession before 2001 ends. The forces that could erode consumer confidence include another spike in energy prices, more damage to a weak stock market, or a worsening job market.

FAIR-WEATHER SPENDERS. Assuming that the same delicate balance holds and central bank policy continues to stimulate consumer spending beyond any fallout from declining stock prices, rising energy prices, and ongoing layoffs, the economy may well manage to avoid the two consecutive quarters of contraction in GDP that -- roughly speaking -- equal a recession. Retail sales numbers support the evidence that consumers, who account for two-thirds of economic activity, are spending. In the first quarter of 2001, they were up by 4.5% over a year earlier.

Spending trended downward in February and March after a very strong January, but some of the falloff was due to nothing more dramatic than bad weather that kept consumers out of the mall, according to Marci Rossell, chief economist for Oppenheimer Funds. Expectations are that retail sales will stay strong enough for consumer spending to grow by 2% in the second quarter of 2001 as compared to a year earlier -- disappointing, perhaps, but not the makings of a recession.

The labor market's resiliency has been a key factor in keeping confidence from falling further and ensuring that consumer spending continues. Although the unemployment rate crept up to 4.3% in March, that's still well below historical norms. And while economists predict that number might be near 5% before the job market stabilizes, it would still be lower than any year between 1973 and 1997. It's much closer to the 2000 low of 3.9% than it is to the 1983 peak of almost 11%.

TAKING OUT CASH. Other factors are helping offset the impact of rising unemployment. Key among them is lower interest rates, thanks to Federal Reserve Chairman Alan Greenspan. All through the first quarter, consumers refinanced to take advantage of mortgage rates that are now down around 7%, more than a percentage point below where they were a year ago. And all signs are that the Fed is not finished lowering rates.

The money consumers save in debt service and the cash they take out of their homes is money they tend to spend, according to David Berson, a vice-president and chief economist of the Federal National Mortgage Assn. (Fannie Mae). "The current wave of refinancings could generate a $45 billion increase in consumer spending," says Berson. "Part of that refinancing money often goes into auto purchases." Berson believes the refinancing trend will continue for the next several months, as mortgage rates are likely to stay at their current levels for a while yet.

Home values, which rose briskly in most markets the past couple of years, are holding steady, which has also helped consumers survive the damage a stormy stock market has inflicted on their wealth over the past couple of quarters (see BW Online, 4/16/01, "Why It's Still Safe at Home"). And home sales are strong compared against historical averages, even though they weakened slightly in April, according to the Apr. 16 Housing Market Index published by the National Association of Homebuilders. "This January's and February's home sales were stronger than any previous January and February," says Berson, crediting lower interest rates.

HEEBIE-JEEBIES? True, the latest consumer confidence numbers are the lowest they've been since 1993. But they're about midway between its decade peak of around 112 in early 2000 and its low of around 68 at the beginning of 1992, points out Nancy Tengler, president and chief investment officer of San Francisco-based money manager Fremont Investment Advisors.

The same goes for consumer spending. The current estimate is that it grew 3.5% in the first quarter of 2001 as compared to a year earlier. That's slower than its peak growth for the decade of 6%-plus in the fourth quarter of 1999, "but it's not at recessionary levels," says Tengler. In the fourth quarter of 1990 it shrunk by about 1.5%.

Of course, if the consumer suddenly gets the heebie-jeebies and decides to stop spending and start saving, these estimates will prove about as accurate as the average weather report. But some economists are holding steadfast to a sunny outlook. "There is no sign that the consumer is ready to start saving," says Milton Ezrati, senior economist and strategist at Jersey City (N.J.)-based fund manager Lord, Abbett & Co. In fact, new cars are currently being sold at a rate of about 17 million annually, even though manufacturers cut back production to the 10 million to 12 million level late last year. "If sales keep up at this rate, in May we'll see the auto companies rehiring," Ezrati says.

STILL SPENDING. That would signal a huge vote of confidence in the economy's ability to avert recession. But let's not forget the specter of higher oil and gas prices. If they go up suddenly, it could quickly dampen consumer spending. If this cold winter is followed by a hot summer, supplies of natural gas and oil would feel the strain. But by and large, economists expect oil to hover around $25 a barrel, and natural gas to stay around $5 per thousand cubic feet. That's not anywhere near the lows of 1998, but it sure beats the highs of late 1999, when oil hit $37 a barrel.

For a while, nearly all the experts seemed to be focused on the fact that consumers are spending less. But the more important fact may be that they're still spending. And at a rate, if it continues, that could enable the economy to skirt an actual recession. If all the debris on the dot-com landscape hasn't scared them yet, maybe spending will stay strong enough for a bumpy but safe economic landing. Popper covers the markets for BW Online in our daily Street Wise column


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