June 02, 2003

A Stronger Forthcoming Rebound in Investment Spending?

Morgan Stanley's Richard Berner turns pessimistically optimistic about the recovery:


Morgan Stanley: Incoming data suggest that manufacturing is staging a rebound, following a slide netting more than 2% since last August. Is the recovery coming faster than we expected a couple of weeks ago? Certainly several positive fundamentals are in place. Among them: Declining energy quotes, easier financial conditions, increased fiscal stimulus and reduced uncertainty, all of which should boost demand. Moreover, a long spending drought has built some pent-up demand in Industrial America. But it's still a two-tier manufacturing economy, with technology reviving and the rest of manufacturing struggling. Importantly, manufacturers still face two key cyclical obstacles in a tepid global economy and still-high natural gas prices, while high legacy health and pension costs and competition from China represent key secular challenges.

There are certainly glimmers of hope in very recent manufacturing data. Purchasing managers from Chicago and Milwaukee reported a sharp improvement in both orders and overall business conditions in May over April, and their New York brethren announced that manufacturing business conditions stayed at a high level. It still looks like a two-tier manufacturing economy, however (see "The Two-Tier Economy Revisited," Global Economic Forum, May 16, 2003). Technology demand and production continue to improve briskly, with shipments and orders for computers and electronic products up 6% and 2%, respectively in March-April, and IT output up 2% over the same span. Not surprisingly, defense bookings and shipments have also been strong. But excluding tech and defense, both orders and shipments each declined by about 1% in those two months.

There's no mistaking the improvement in the fundamentals, however, and they are setting the stage for recovery. Energy quotes have declined sharply from their peaks; for example, gasoline prices have fallen 14% in the past two months. Financial conditions have turned easier: Interest rates have declined to 45 year lows, credit spreads remain narrow, fewer banks are tightening lending standards than at any time since 1999, stock prices have rebounded to levels last seen in August, and the dollar has depreciated by 19% on a trade-weighted basis against major trading partners since its peak early last year. The just-signed Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) should add fiscal stimulus amounting to 1% of GDP over the four quarters beginning in the summer, so while it doesn't pack a lot of bang for the buck, it has more heft than any tax change since the Reagan tax cuts in 1981 (see "How Does this Tax Cut Stack Up" Global Economic Forum, May 30, 2003). Together with these three factors, reduced uncertainty likely will contribute to increased consumer and business demand in coming months.

Apart from technology, a long capital spending drought has built some pent-up demand for capital spending that should help Industrial America, and JGTRRA includes extra investment incentives that we hadn't counted on. That flies in the face of the bearish side of the capacity/capital spending overhang debate. Bears maintain that the world is awash in capacity, citing the low levels of capacity utilization in manufacturing and the global overhang of excess capacity, notably in China. But it's worth recalling that manufacturing itself only accounts for 20% of capital spending, so by focusing only on factory utilization rates, we're missing four-fifths of the story. And I still assume that the beleaguered and capacity-glutted telecommunications and airline industries will be slashing capex this year by 25% and 30%, respectively.

In my view, the bears are overlooking the simple analytics of depreciation that has, with the passage of another year, eroded the stock of equipment and software and brought capital in relation to output nearly to a standstill. The revival in low-tech equipment spending has yet to begin, although real capital outlays for such gear fell to 1.1 times real depreciation...

Posted by DeLong at June 2, 2003 10:23 AM | TrackBack

Comments

If you believe as I do that the stock market is setup to cause maximum pain to the greatest number of people then a big stock market recovery, growth heading up to 3.5% by the fourth quarter and the reelection of bush will serve to drive half the population mad.

Posted by: William Utley on June 2, 2003 11:19 AM

Why would manufacturing rebound in the US when labour costs are 10x those in China?

Posted by: brian on June 2, 2003 11:42 AM

And the bear argument is that stocks are still overvalued according to P/E ratios. According to some of the bear analyses I have seen, the economy would have to grow just to bring current stock prices in to historical levels of valuation. I suspect that they are correct and we are seeing one of many run ups in stocks that will collapse to more rational less exuberant levels. Maybe I should reread Krugman's Ice Age column.

Posted by: bakho on June 2, 2003 11:47 AM

If I read this correctly, it is all about anticipation of demand reviving, but not observation of this. But can demand revive with consumers and businesses holding this much debt?

Posted by: IssuesGuy on June 2, 2003 11:52 AM

There are all sorts of reasons being given for why stocks are rising in price - low interest rates or traditional recovery pattern from bear markets - but the p/e ratio for the S&P was 30.5 at the end of April.

Posted by: jd on June 2, 2003 11:59 AM

I seem to remember reading here a while back, maybe a month or two ago, Prof. Delong quoting Stephen Roach as saying the odds that we would slip into a double dip recession as being 50-50. Looks kinda wrong at this point. I think the economy will have turned around by the end of this year and growth will have picked up somewhat (3.5%) with the stock market up maybe another 10 percent from today's levels. The great thing about the market and the economy is that one can see whether one is right or not at the end.

Posted by: William Utley on June 2, 2003 02:26 PM

The market is not the economy and the 2 do not necessarily move in concert. With over $400 Billion in deficit spending, we should be getting some economic stimulus to pick up the economy. If current deficits do not work look for even more deficit spending from Bush to make the economy good for the 04 election. Bush will do what it takes including sacrificing the future fiscal picture for re-election in 04.

Posted by: bakho on June 2, 2003 02:50 PM

"I seem to remember reading here a while back, maybe a month or two ago, Prof. Delong quoting Stephen Roach as saying the odds that we would slip into a double dip recession as being 50-50. Looks kinda wrong at this point."

Really? How do you judge this probabilistic statement to be "wrong?"

Posted by: Cheez Whiz on June 2, 2003 05:39 PM

Brian,

Two things: lots of excess capacity in the US and a lack of complete overlap between US and Chinese factory output should mean that a pick up in demand will lead to a pick up in US factory output. Until US producers decide that any an every product made in the US can be more profitably made in China (accepting the political risk inherent in that decision), a pick up in factory output will at some point lead to higher factory sector capital investment. Then, there is capital investment in the non-factory sector to consider...

On the issue of stock pricing, the last time P/Es were anything like as out of whack as they recently have been, it took from the mid-1960s till about 1982 to get things back in line. While there were some ugly periods of price decline, much of the adjustment was accomplished by prices not doing much untill earnings caught up. That would be a very different investment environment from the one that many investors cut their teeth on in the 1990s and also different from what I take to be the final days of a very long bond market rally, in which investors shifted profitably from stocks to bonds and real estate. The up-and-down, sideways behavior of stock prices in such an environment is a nightmare for little guy investors (hell, for unlucky big guys) because there are some tempting periods of appreciation which end in tears over and over again.

Posted by: K Harris on June 3, 2003 06:20 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:31 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:31 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:31 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:31 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:33 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:33 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:33 AM

Since W has an MBA [from Harvard?] have any of his professors weighed in on the merits of his economic policy?

Posted by: felix on June 3, 2003 11:34 AM
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