July 01, 2002

Forecasts for Continued Slow Expansion

The Wall Street Journal's Jon Hilsenrath reports on its survey of forecasters: continued growth and recovery for the next year and a half, at least. What he doesn't say is that this consensus forecast implies stationary or perhaps slightly rising rates of unemployment.


WSJ.com - Major Business News | Economists Have Faith Expansion Will Continue | by John Hilsenrath

...economists have a surprisingly rosy view of the outlook for the economy in the months ahead.With nearly complete and uncharacteristic unanimity, forecasters polled by The Wall Street Journal in late June said the economy will continue to grow throughout the year and won't make a return trip into recession, a fear that has been creeping into the financial markets in recent weeks.

The consensus forecast of the 55 economists who completed the survey is for real gross domestic product, the nation's broadest measure of economic health, to grow at a 3.5% annual rate in the second half of this year and at a 3.6% rate during the first half of next year, adjusted for inflation. That is slower than is typical in the early stages of an economic recovery, and far slower than the brief 6.1% growth rate recorded during the first quarter of this year. But it beats the consensus of about 2.5% growth in the quarter just ended. Perhaps more importantly, the prediction of steady second-half growth provides a stark contrast to the gloom that currently pervades the stock, bond and currency markets...

Economists Have Faith Expansion Will Continue

The Gloom Currently Clouding Stock,
Bond Markets Fails to Sway Forecasters

By JON E. HILSENRATH
Staff Reporter of THE WALL STREET JOURNAL

NEW YORK -- Even as stock prices tumble, corporate accounting scandals brew, the mighty U.S. dollar sinks and the war on terror remains headline news, economists have a surprisingly rosy view of the outlook for the economy in the months ahead.

With nearly complete and uncharacteristic unanimity, forecasters polled by The Wall Street Journal in late June said the economy will continue to grow throughout the year and won't make a return trip into recession, a fear that has been creeping into the financial markets in recent weeks.

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The consensus forecast of the 55 economists who completed the survey is for real gross domestic product, the nation's broadest measure of economic health, to grow at a 3.5% annual rate in the second half of this year and at a 3.6% rate during the first half of next year, adjusted for inflation. That is slower than is typical in the early stages of an economic recovery, and far slower than the brief 6.1% growth rate recorded during the first quarter of this year. But it beats the consensus of about 2.5% growth in the quarter just ended. Perhaps more importantly, the prediction of steady second-half growth provides a stark contrast to the gloom that currently pervades the stock, bond and currency markets.

"The basic story continues to be that the economy is on an expansion track," said Richard Rippe, chief economist for Prudential Securities. "It is a good expansion, with solid support from economic policy, but it was never going to be a barnburner."

Consistent growth could put upward pressure on interest rates, these economists said, but not much. By year end, according to the consensus, the Federal Reserve will have nudged up the benchmark federal-funds rate to 2.25%, from its present level of 1.75%. Only one economist says the Fed will cut rates again to fend off a flagging economy.

In the face of so much bad news about stock prices, corporate malfeasance and terrorism, why do economists remain so seemingly sanguine? Some of the answers are obvious. The housing market is still booming, thanks in part to exceptionally low interest rates. Federal spending related to the war on terrorism and tax cuts are giving the economy an added boost. Inventories are trim. And consumer spending has been resilient, even though it has slowed a bit in recent months.

[Annualized growth chart]

Another surprising explanation lies in the very profit and loss statements that have become the bane of Wall Street in the face of mounting accounting scandals. With the latest disclosure that WorldCom Inc. accounted for $3.8 billion in expenses inappropriately, many investors have come to the conclusion that they just can't trust the numbers being reported by corporate executives. Yet many economists say beneath the surface in those statements, a respectable profit recovery is quietly taking root.

They say the aggressive cost cutting that has taken place in the last two years and an intense focus on improved productivity are slowly helping many companies to repair tattered profit margins. Their argument is easily lost amid the growing doubts about what these companies report. But 42 of the 55 economists surveyed said they expected companies to register double-digit percentage profit gains in the next 12 months. Only one sees continued declines.

"Profits are improving faster than people thought they would, but nobody knows whether to believe them," said Diane Swonk, chief economist of Bank One Corp.

The profit forecast might well be wishful thinking. But it is understandable how economists could be more optimistic about profits than investors are at this point in a recovery. By and large, economists don't look too closely at the profit and loss statements reported by individual companies. Nor do they focus as much attention on profits of the companies that make up the Standard & Poor's 500-stock index, as does Wall Street. These figures remain inscrutable at best.

Instead, the economists tend to track government statistics that record profits for a wide swath of American companies, small and large, public and private. In addition to being broader-based, the government figures are different statistically from Wall Street's. The government figures include seasonal adjustments that allow economists to track changes from one quarter to the next. Using these figures, profits have shown some real signs of improvement since late last year. In the first quarter, this broad-based measure of profits was up 19% from its bottom in the third quarter of last year.

A profit rebound is especially important to the economic outlook. Economists agree that business investment isn't going to pick up until profits recover, and that the broader recovery will be wobbly until such investment takes place. Furthermore, companies aren't going to stop cutting costs, like labor, until after they see that their bottom lines are in better shape. So the outlook for the job market also hinges on a discernible improvement in profits. The consensus projects the unemployment rate will hold steady at 5.8% through November, before edging down to 5.5% by the middle of next year.

"Job growth will pick up next year, but for right now the reason profit margins are widening so much is that companies are very circumspect about hiring workers," says Bruce Steinberg, chief economist with Merrill Lynch.

This is not to say that the twin problems of a weak stock market and mounting accounting scandals are not causing some economists to waver about their outlooks. In fact, if there is a divide among economists today, it is over how much weight to give the market's woes in their forecasts. "We're worried about what this steady erosion in stock prices might do to confidence," says Stephen Slifer, co-chief U.S. economist with Lehman Brothers. Falling confidence could undermine consumer spending, and it can also undermine business spending plans, he says.

Last week, Mr. Slifer and his colleague Ethan Harris were so shaken by the WorldCom announcement and the market woes that they cut their forecasts for second-half growth from 3.5% to 3%. They also decided that with the markets so vulnerable, there was no way the Fed could raise rates this year, as they had expected.

In all, 11 economists in the survey listed falling stock prices as the biggest risk to the recovery today. Back in December, only one listed the market as a primary concern. Furthermore, 29 economists said the accounting scandals would have a negative long-term impact on the economy, by making it harder for companies to raise money from equity markets and damaging business confidence. Many others listed the threat of terrorism as the biggest risk.

The problem with all of these risks is that they are hard to quantify. For years, for instance, economists have tried to measure the "wealth effect," how much a falling stock market affects consumer spending. Yet they still don't have a handle on it. Unable to quantify the impact of much of today's turmoil, many of them are simply sticking to their guns. So far, the economy has proved to be incredibly resilient through terror attacks, accounting scandals and falling stock prices. And they don't expect that to change.

Other findings in the survey included the following:

 Economists, rarely bold about predicting currency moves, see little change in the value of the dollar in the next six months -- even though it has fallen 8% in trade-weighted terms since April. They aren't alarmed about the drop, either; 32 of the 55 economists said a weaker dollar would benefit the economy, either by increasing the competitiveness of U.S. exports or by improving the profits of American companies that derive revenue from abroad.
 

 Only eight economists said that the housing market is in a bubble and only two cited it as a major risk to the economy. Forty-six said it isn't even a bubble, an opinion shared by Federal Reserve Chairman Alan Greenspan in recent public comments.
 

 Economists are bullish on the stock market, but not enough to put their money on the table. Of the 55 economists polled, 37 said they expected the Dow Jones Industrial average to finish the year above 10000. Yet 30 of the 55 economists said they had reduced their holdings of stocks in the last 12 months, 17 of whom are expecting the market to bounce back. Only 12 economists said they had increased their stock holdings.
 

Write to Jon E. Hilsenrath at jon.hilsenrath@wsj.com5

Posted by DeLong at July 1, 2002 08:52 PM

Comments

What he doesn't say is that this consensus forecast implies stationary or perhaps slightly rising rates of unemployment.To be fair, even if unemployment rates rise modestly from here, they will still mark the lowest unemployment peak for a recession in modern history.

Posted by: George Zachar on July 2, 2002 09:48 AM
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