Economic Recovery Slow but Steady--So Far

Shortly after George W. Bush was inaugurated, I asked one of his leading economic advisors if he was as pessimistic about the near-term economic outlook as his candidate had professed to be during the campaign. The short answer was "Yes". The longer answer was that he expected that the Republicans would face a tough battle in the November 2002 congressional races because by then the unemployment rate would be around 6%, and the Dow Jones Industrial average close to 8,000. This, at a time when the unemployment rate was 4% and the Dow stood at around 10,600.

This unhappy outlook was relayed to me at a time when Enron was still the darling of investors, Arthur Andersen was the auditor of choice for many companies, and al Qaeda was a name known only to President Clinton and a few of his advisors. None of these negatives had been factored into the Bush team's cheerless forecast.

Flash forward to the present. The unemployment rate did indeed rise to 6%, before falling in May to 5.8%, and the Dow stands at around 9,600 and seems headed downward, with another 15% decline ahead if his post-election prediction comes true. The odd part is that all of this is happening when, according to the world's most respected economic guru, Federal Reserve Board chairman Alan Greenspan, "the American economy is in an upswing."

Life for economists would be far easier if Greenspan's upswing translated into jobs and higher share prices. But, as the Fed chairman well knows, that is not the case. For one thing, the upswing is "not going to be dramatic," Greenspan told his Montreal audience last week. No surprise there: the recent downturn was extraordinarily short and mild. So the sharp bounce-back characteristic of earlier, more severe recessions is just not in the cards.

The more important question is whether the current recovery is merely a temporary bounce as depleted inventories are rebuilt, or a more durable return to long-term, steady growth. Most of the signs point to sustained recovery. The service sector, which accounts for perhaps 80+% of US economic output, grew last month at the fastest rate in two years, and order backlogs will keep it in good shape through the summer. The manufacturing sector, too, is doing better. Increasing new orders resulted in the fourth consecutive monthly increase in manufacturing activity in May, with activity in the industrial heartland, the Midwest, at a three-year high.

In short, it seems that the inventory build-up may finally be supplemented by the increase in business investment that is crucial to a sustained recovery. The Commerce Department reports that orders for machinery rose 4.5% in April, orders for electrical equipment 9.6%, and demand for computer and electronics products by 3%.

Indeed, even the media industries are seeing signs that the worst is over, with ad sales in the early days of the new televisions season well up on last year for most networks, with the exception of Disney's beleaguered ABC, which can't seem to find programs that people want to watch.

To add to the good news, consumer sentiment is at its cheeriest since December 2000. This may explain the continued boom in house prices. The National Association of Realtors reported last week that average house prices rose 9% in April, the largest year-over-year jump in more than a decade. Soaring prices have enabled consumers to "mortgage out," converting their increased equity into ready cash for use in the nation's shops and malls.

Only the auto industry seems to be hitting a rough patch. In response to an easing of discounting, sales dropped by 6% in May, to the lowest level in more than three years, with General Motors and Ford suffering declines of 12% and 11.5%, respectively. This has triggered a new wave of profit-depleting discounts, as automakers slash prices of best-selling minivans, pickup trucks, and sports utility vehicles.

But autos aside, the economic news is good. Unfortunately, investors don't seem to be impressed. The market value of all shares in the broadest index, the Wiltshire 5000, which hit a low of $10.2 trillion immediately after the attack on the World Trade Centre and the Pentagon, peaked at $12.6 trillion on March 19. It now stands at around $11 trillion, a drop of 10% from the peak.

The reasons for investor squeamishness in the face of good economic news are almost too many to list here. There are the unsettling fears of renewed terror attacks, a nuclear war between India and Pakistan, and a conflagration in the oil-rich Middle East. There is a worry that the gentle slide in the dollar may turn into a rout, unleashing inflation and forcing the Fed to raise interest rates. There is a lack of confidence in profit reports, not unreasonable in light of the almost daily announcements that figures have been massaged in the past to make them less than completely revealing of the financial condition of the reporting companies. There are worries that earnings will lag even as the economy recovers.

No one can predict whether terrorists will strike again, although the administration considers this a certainty. But the modest decline in the dollar does not necessarily presage a collapse, and may prove to be a good thing, stimulating exports and cutting the trade deficit and pressures for protectionism. Fears about jiggered reporting will dissolve as new corporate governance rules are put in place, and auditors decide that pleasing clients isn't worth a possible stay in a federal penitentiary. And profits may prove to be better than expected, as rising output spreads fixed costs over larger volumes, and a less than vigorous job market prevents unit labor costs from rising.

Still, investors worry, and many have decided to sit out the summer, waiting for rising profits and falling share prices to reach levels that establish a new share-price plateau. When they have closed their beach houses, the kids are home from summer camp, and corporate balance sheets have been cleaned up, the bulls may emerge. Meanwhile, the summer is when the bears feast in preparation for a winter's hibernation.



This article originally appeared in London’s Sunday Times on June 9, 2002, and is reprinted with permission.