March 20, 2002

Economists and business leaders currently have a remarkably different view of  the economy.

My monthly analysis suggests that economic activity may have stopped falling as early as last November.  That sharp upward revision in fourth quarter GDP certainly benefited from the surge in activity during the latter part of December. 

Economic activity probably was flat in January.  However, this is substantially better than my preliminary estimate which showed a considerable decline in activity.  That plunge in the workweek that was reported for January a month ago was revised away in the latest employment report.

According to the Institute of Supply Managers , both the manufacturing and services economies had more companies reporting gains than losses in production in February.  In other words, another month of strong economic activity, comparable to the December gains, probably occurred in February (if these gains are not revised away in subsequent reports). 

While this stop and go pattern of economic recovery is not dramatic, it certainly is better than the sequential decline in almost all indicators that began in March (or almost a year earlier for manufacturing activity).  I probably would not have used Greenspan's phrase that "the recovery is well underway", but I certainly believe that we are recovering. 

Why are CEOs unwilling to accept this declaration that economic conditions are getting better.  Indeed, Intel actually cut is projections for capital spending this year to $5.5 billion from $7.3 billion in the previous year.  Such cutbacks are not made by companies that are experiencing improving conditions. 

Normally CEOs are behind economists in predicting the performance of the economy.  They tend to assume sluggishness at the peak is temporary, thus delaying the shift in production that will moderate inventory excesses. 

At the bottom of recessions, profits remain deeply depressed.  Thus, many companies continue to cut employment and capital spending well into recovery.  Indeed, corporate bankruptcies tend to rise well into the first year of economic recovery. 

In growth industries, CEOs expect earnings every year to be better than in the previous year.  When a recession occurs, these expectations are not realized.  Thus, the company is shocked by the deterioration in financial conditions. 

Until earnings are restored to their previous peak, CEOs remain wary about the economy.  Only a year ago, for instance, most industry leaders thought corporate profits would be flat to slightly up.  In fact, operating profits have declined by nearly 21 percent in the past twelve months. 

To get earnings back to record levels, more than a year of economic expansion will be needed.  In other words, CEOs believe the recession is over when the economic hole is filled.  Economists define the end of recession when we are starting to climb out of the hole. 

Could the CEOs be right this time?  They experienced a slight spurt in orders once a stunned nation got back to work following the atrocities of September and October (anthrax).  However, that spurt has been very uneven. 

Some analysts already are calling for a double dip recession.  Virtually all forecasters acknowledge that inventory liquidations have been so extreme in the past two quarters that production must rise, if only to end the rapid decline in warehouse holdings. 

However, once that adjustment is completed, the excessive debt of consumers and continued low utilization of capital will combine to slow consumer and fixed investment expenditures.  A strong dollar also may contribute to further weakness in exports despite signs that the world economy is showing some signs of improvement.  (Stock markets in Japan and Latin America have experienced significant improvement in the past few weeks). 

While this argument of renewed weakness is possible, tax cuts and monetary stimulus suggest that it is unlikely. Indeed, consumer debt may be at record levels, but the percentage of monthly income needed to support that debt has been falling for much of the past year. 

Fixed investment expenditures may be slower to recover.  Construction decisions are made many months before activity changes.  Thus, the cutbacks caused by recession are just now beginning to reduce employment. 

Nevertheless, I expect capital spending to improve once profits begin to grow.  If my analysis is right, profits should be higher than the past year as early as this summer. 

Lighten up CEOs, the economy is no longer as bad as you think. 


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