July 07, 2003

Reply Hazy, Ask Again

Morgan Stanley forecasts that the economy will either "muddle through or gain steam." I don't, however, understand their expectation of a radically different tone to the labor market in a few months--remember, at the average post-1995 labor productivity growth rate, we need about 3.6% per year real GDP growth just to keep the unemployment rate from rising.

Morgan Stanley: ...Thus, it's far from catastrophic that convincing evidence is so far lacking for a meaningful economic acceleration.  But it does speak to the fact that consumers and businesses remain cautious.  Courtesy of declining energy prices, consumers clearly stepped up their spending pace in the last few months; real outlays rose at a smart 4.4% annualized clip in the three months ending in May, compared with a 2% rate in the first quarter.  But their appraisal of current economic conditions has essentially been unchanged for the past nine months, hinting that the faster pace isn't sustainable without improvement in fundamentals, namely income and jobs.

And that's our key worry: Business hiring caution has kept the recovery jobless, with the current experience marking the worst employment performance of any postwar recovery.  We expect a dramatically different tone to labor markets soon, as the stimulus further lifts both spending and profit margins.  In that regard, there are two pieces of good news in an otherwise tough job market: First, temporary help employment, which we think is a leading indicator of employment demand, rose by 82,000 in the past two months; that's the second-biggest two-month rise in temp employment in a decade.  In addition, small-business optimism and hiring intentions picked up steadily in the past three months, and we'd agree that small businesses are likely to hire first.  But it's a long way from those signs of improvement to vigorous, above-trend growth.

Whether growth is above or below trend in coming quarters is critical for our calls for a rebirth of pricing power and for renewed job growth.  In our view, above-trend growth would stop the widening in the so-called "output gap" -- the difference between actual and potential GDP -- which we estimate to be about 2%.  A wider gap represents growing slack between supply and demand, which tends to put downward pressure on pricing.  We believe that both the analytics and incoming data support our call for a rebirth of pricing power (see "The Rebirth of Pricing Power: Growing Conviction," Global Economic Forum, June 20, 2003), with capital exit, a Fed commitment to fight deflation, a weaker dollar, and stronger growth as the key ingredients.  But that view still is way out of consensus, given that "core" consumer inflation however measured ran at or below 1.1% annualized in the first five months of 2003.  Above-trend growth would also revive business confidence in a sustainable expansion, assuring renewed job growth.

Whether the economy will merely muddle through or gain steam is also critical for market participants and policy makers alike.  Our strategists believe that both equity and credit markets are already priced for improvement, so a significant growth shortfall or a pickup in volatility likely would depress stock and corporate debt prices.  For example, Morgan Stanley quantitative strategist Qi Zeng estimates that stock prices reflect roughly 3.5% real growth and 3.2% inflation by year-end.  For their part, policy makers are implicitly betting that recovery is around the corner, and that they've done much to set the stage for improvement.  We think that is the right bet, and that Fed officials are unlikely to ease monetary policy further.  At the same time, we believe that the Fed will not only tolerate but welcome several quarters of above-trend growth before feeling comfortable that deflation risks are past.  In our view, that means a protracted period of stable, and very low, short-term interest rates and further steepening in the yield curve...

Posted by DeLong at July 7, 2003 10:42 AM | TrackBack


After the June employment report, I listened to or read analyst after analyst explain why the economy really was improving and the employment report really was better, lots better, than it seemsed to be. Phooey. Look at where African-American adult unemployment is, for example, and then tell us how the economy is improving. We have a jobs problem that shows no signs of resolving itself and there is little help coming from the tax cut. Explain to the large number of African-American women who lost jobs these last 3 months how much the economy is improving.

Posted by: lise on July 7, 2003 11:10 AM

*takes a deep breath*

Once again - how are we going to raise aggregate demand? The tax cuts will do little, and may be completely offset by higher state and local taxes and reduced government spending.

I hate to sound like a broken record, but there is no giant market out there ready to suck up goods and services produced in the US.

And, I agree with a previous poster who asked why some economists keep talking bullish. Perhaps they're just talking bull?

All kidding aside, Iraq is not producing oil yet and probably will not do so for some time, the strike in Nigeria could send prices to above $35, etc. etc.

I have yet to see a rational economic policy for navigating these dangerous waters.


Posted by: SZ on July 7, 2003 11:32 AM

You have to love a good liberal. Even the lousy job market has a racial angle. Just another excuse for "the Man" to stick it to those African American women.

Posted by: Joe Blog on July 7, 2003 11:59 AM

It is very peculiar.
It is almost as if the working economists at the Investment houses are trying to talk up an equities rally so that their firms can make a little profit in 2003.
This is the essential problem. There is no profit in bad news.

I also think there is a bit of mass delusion among the market makers. A buddy of mine works the bonds desk at the Montreal Stock Exchange. He was commenting how in 2000 when Bush finally won the market rallied. The assumption being that Republicans are good for business and good for the stock market.

But Republican behavior has factually been very poor for the economy and only of marginal benefit to the market. I just think it is really hard for decision makers on wall street and the larger business community to see with new eyes.
You mean I have to change my belief system? Republicans are irresponsible and drag down the economy? Democrats are good for GDP growth?

This disabusing of expectations will make the coming correction even more brutal.

Posted by: Scott McArthur on July 7, 2003 12:08 PM

Racism is alive and well it seems. If you had bothered to read the June employment report you would have noted that there has been a lrge jump in unemployment for African-American women, and that the unemployment lvel for African-American adults [over 20] has climbed to about 10.5%. If you are too steeped in prejudice to allow for such a fact, too hell with you.

Posted by: jd on July 7, 2003 12:19 PM


Professor Rebecca Blank
University of Michigan

What we're seeing now in these last few months is a much more traditional pattern that we often see in recessions where it's the least skilled and the lowest waged workers who lose their jobs. If you look at this report, the big jumps in unemployment are among people who are less skilled, they're among people who are in blue collar jobs, they're among teenagers -- black male teen unemployment is now up to almost 40 percent again, a number we haven't seen in quite a while. They're among persons of color, among blacks and Hispanics.

Posted by: jd on July 7, 2003 12:23 PM


"The Labor Department said that for blacks, the unemployment rate in June was 11.8 percent, up from 10.8 percent in May. For whites, it rose to 5.5 percent in June from 5.4 percent a month earlier."

Posted by: jd on July 7, 2003 12:27 PM

I agree with you Scott:

This week's Economist has a series of articles that strongly imply fund managers have been more than willing to use their clients trust against them, often selling them hyped stocks at their peak.

However, I think the market itself will stay somewhat up for the near-term because, for all the talk of global fluidity, there isn't really a better place to put your money. Too many investors got burned in the developing world, and neither Germany nor Japan offer an alternative.

Has anyone else begun to examine the effects that the baby-boomer retirement will have on the stock market? By my quick-and-dirty calculations, it could mean a drop of about 20 percent in real value between 2008-2020.


Posted by: SZ on July 7, 2003 12:37 PM

I think that Asia [Japan] offers a well priced alternative to the American stock market. European stocks are also better valued. The point is not to time stocks according to the economy but to look to valuations. I rather like Asia [Japan] and have for months. Yes, I have bought Japanese stocks since March!

Posted by: bill on July 7, 2003 12:49 PM


Thanks, much.


Posted by: lise on July 7, 2003 12:52 PM

It is a tough job market for any American looking for work regardless of skin color: black, brown, white, or whatever. And each unemployed person is 100% unemployed and is generally facing a difficult situation. And as to the racial angle you take on it, I probably like most people really don't give a damn. And I am a "person of color" for what it's worth.

Posted by: Joe Blog on July 7, 2003 12:58 PM

Nonetheless, your comment was needlessly harsh!

Posted by: arthur on July 7, 2003 01:01 PM

"Nonetheless, your comment was needlessly harsh!"

True, better left a personal thought and unsaid. Another case of the mouth (or keyboard) working quicker than the brain.

Posted by: Joe Blog on July 7, 2003 01:09 PM

Why is the unemp rate for women almost a full percentage point lower than for men? Any thoughts?

Posted by: Snrub on July 7, 2003 02:08 PM

Brad, why should we believe anything that comes out Morgan Stanley? Didn't an NY judge tell us, just last week, that any smart person knows these people lie for a living and that anyone believing them has only himself to blame?

Posted by: Maynard Handley on July 7, 2003 02:20 PM

Women are more likely than men to work domestic jobs off the books. Unemployment is only people looking for work, not people that don't have jobs.

Posted by: bakho on July 7, 2003 02:32 PM

A friend of mine asserts that is likely a secondary stock bubble forming. I find that quite credible - there have been large influxes of money into the stock market that are not based on any underlying economic numbers that would justify them. Now maybe the stock market is pricing in a real recovery that I don't see yet, but I think it's more likely that it's simply another unsustainable run up.

Also - the economic analysis forecasts of the big brokerage houses (and their public analysis of any sort) should be met with deep suspicion by anyone who's been keeping track over the last few years. They're practically a contrary indicator at this point.

Posted by: Ian Welsh on July 7, 2003 08:18 PM

The better jobs outlook was explained today by Commerce Secretary Evens on CNBC. He is "very optimistic" about a turnaround in factory employment due to productivity gains.

The issue that Brad raised seems to have taken on a life of its own. I understand the intense focus on employment as a measure of the health of the economy. However, it should not be taken as an indicator of the direction that the overall economy is taking. It is very hard to see how employment could lead us out of the slump into better growth. Rather, after a long demostration of factory managers skill at boosting productivity to avoid hiring, we must anticipate that orders and sales will lead employment, maybe by a lot. If you want to know whether the economy is improving, a Fed-like appetite for a broader range of data is advisable. The Morgan piece notes an acceleration in household spending. Hurray! The non-factory ISM index hit its highest reading in almost 3 years in June. Hurray! The factory ISM index failed to crack above 50 again in June, but largely due to a sharp drop in inventories -- orders and shipments held in positive territory. Shrug.

I'm not wild about Morgan's confidence in the temp hiring data. Given that temp hiring could mean different things in periods of employment growth and employment decline, we could be misled by the one-size-fits-all notion that temp hiring portends permanent hiring. In June, temps replaced full-time employees, at least in aggregate. Could it be that they replace full-timers in reality, as well? Benefits costs, now rising sharply, can be avoided by replacing full-time with temp staff.

Posted by: K Harris on July 8, 2003 07:20 AM

Important employment comments. Yes, I am still quite worried. This is not typical. The loss of jobs in manufacturing is endless, and these are largely fine jobs. Manufacturing jobs will not be coming back, and we must ask whether service sector jobs really substitute. Also, there is more and more competition for service sector jobs from Asia. We had best be concerned.


Posted by: anne on July 8, 2003 09:18 AM
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