Will Wall Street Squash Growth?
BusinessWeek Online
August 5, 2002
If the market rout continues, consumers and execs could cut spending--and slow the recovery
To hear most economists tell it, growth is on a glide path to a vigorous expansion. Consumer spending is still strong, and the housing market remains buoyant. With corporate profits for most companies perking up, the last pieces needed for a full-bore recovery are about to fall into place: stepped-up hiring by business and increased capital spending.
It all sounds just fine. And a lot of the economic data even seems to bear it out. There's just one problem. Should the savage sell-off in the stock market continue, it could swamp all that good news and turn economists' rosy scenario into a far darker one. The sudden swoon in shares has left investors shell-shocked. Despite July 24's huge rally, the market is still off 13.6% since President Bush spoke to Wall Street earlier in the month. Even if a rally develops, the market slide has finally driven home to Americans that they can no longer depend on the stock market to do their saving for them. That's got many reassessing their free-spending ways. "Now I'm not going to get a new BMW," says 28-year-old Scott McAuliffe of Atlanta. "Instead, I'm going to get a used Honda Accord." Multiply that caution across millions of Americans and it's easy to see why trouble may be brewing for the economy despite a recovery that ostensibly began at the start of the year.
But it's not just personal consumption that will be at risk if stocks keep sliding. The collapse of the market and the vilification of once-venerated CEOs are threatening to paralyze corporate decision-making. Faced with a barrage of criticism from shareholders and lawmakers, corporate chieftains are hunkering down, focusing on cleaning up balance sheets rather than building business. They're delaying expansion plans and putting off hiring. That's imperiling the much-hoped-for business-led bounce in the economy in the months ahead. "The market is telling us the economy is going to be very weak in the second half," says James W. Paulsen, chief investment officer for Wells Capital Management.
How weak? Well, most macroeconomic models, including those employed by the Federal Reserve and the White House, reckon that the collapse in stock prices this year will shave anywhere from a half to one full percentage point off economic growth in the coming year. Says White House chief economist R. Glenn Hubbard: If stocks don't recover, "it would be a substantial effect. But it wouldn't derail the recovery."
Those models, though, assume that interest rates fall in response to the carnage in the stock market, cushioning the blow to the economy. Treasury bond yields and mortgage rates have dropped as stocks have tanked. But worries about the veracity of corporate balance sheets have kept corporate bond yields from enjoying a similar fall. And Fed Chairman Alan Greenspan has shown no sign yet of being willing to cut short-term interest rates, although Greenspan would undoubtedly act if the financial markets suddenly seized up. There was a whiff of that happening early on July 24 as Treasury bond yields plunged on a flight by investors to liquidity. But the danger passed as the stock market rallied.
What's more, the models don't pretend to predict whether the crisis on Wall Street will lead to a wholesale breakdown in confidence on Main Street. "The sharp break in the stock market creates uncertainty, and the uncertainty itself can have an effect on spending," says Chris Varvares, president of consultants Macroeconomic Advisers LLC.
So far, that doesn't seem to be happening. Yes, consumer confidence tumbled in July to its lowest level in eight months. But comments from retailers, auto dealers, and others on the front lines of the economy suggest that consumption is fraying, yet not cracking, under the strains of the stock slump. Retail sales actually rose 1.1% in June, although since then they've been mixed.
Thanks to the reintroduction of 0% financing, carmakers' sales soared in July, a fact cited approvingly by Greenspan. And the housing market, buoyed by a recent plunge in mortgage rates, remains strong. "We are not seeing any indications that the consumer is pulling out of the housing market," says Stuart A. Miller, chief executive of Lennar Corp., one of the nation's largest homebuilders. "To the contrary, people are looking more favorably on the housing market [as stocks sink]."
In industries closely linked to housing, though, the market sell-off has clouded otherwise sunny skies. In a disturbing disconnect, Stanley Furniture Co. in Stanleytown, Va., has seen furniture sales slide even as the housing industry has continued to boom. "If the evening news leads off with `another bad day on Wall Street,' then that's tough," says CEO Albert L. Prillaman. "Consumers are taking advantage of low interest rates but living with some empty rooms for a while."
Some other areas of the economy that service consumers are also not faring well. Companies as diverse as airline UAL Corp. (UAL ), appliance maker Maytag, and high-end consumer electronics retailer Tweeter Home Entertainment Group Inc. (TWTR ) all reported a sudden sales slump in June, coinciding with the stock slide. Says UAL President Rono J. Dutta: "It looks like things stalled."
Call it payback for the go-go-years of the late '90s. As stock prices zoomed ahead at the end of the last decade, personal wealth soared, reaching a record high of 622% of aftertax income in the first quarter of 2000, the height of the bull market. Not surprisingly, given the pumped-up value of their portfolios, many Americans felt comfortable saving less and spending more. The savings rate, as measured by the Commerce Dept., fell all the way to 0.4% personal disposable income in September, 2000, from 6.1% in 1994, before the boom.
For a time after the stock market peaked, the relentless rise in housing prices helped cushion the blow from Wall Street as homeowners saw the value of their real estate increase. But the startling acceleration in the stock market slide in recent weeks means that's no longer the case. According to calculations by Merrill Lynch & Co. chief economist Bruce Steinberg, personal wealth as a percentage of income is now back to about 485%. That's a level not seen since the mid-1990s, before the boom. To make up for the evaporation of so much wealth, argues Goldman, Sachs & Co. Chief U.S. Economist William C. Dudley, Americans will need to raise the savings rate back up to the pre-boom levels of an average 8%, from 3% now.
Corporate America, of course, has already done a lot of housecleaning since the late '90s. Companies have slashed inventories and cut back business investment. With corporate balance sheets in better shape, the hope was that companies were now poised to sharply step up spending and hiring.
Better think again. If the stock market slide continues, corporate chieftains will remain cautious, and could think twice about boosting capital investment. That's already hitting equipment suppliers--from IBM (IBM ) to Caterpillar Inc. (CAT ) And in some cases, such as telephone equipment maker Lucent Technologies Inc. (LU ), it's even prompting a new round of layoffs, putting the economy further at risk.
That means that the dreaded double-dip recession can't be ruled out, especially if share prices fall further. Indeed, chief global economist Allen Sinai of consultants Decision Economics Inc. puts the chances of a downturn during the next 18 months as 1 in 3, even if stocks stabilize.
Unless stocks stage a major turnaround, an extended period of slow, disappointing growth looks likely. During the go-go years, Greenspan reckoned that the booming stock market boosted economic growth by one percentage point per year. Now the reverse is happening. So instead of the the 3 1/2% to 4% annual growth most economists envisage over the next 18 months, the U.S. may have to settle for something closer to 2 1/2%. It won't feel good or look particularly pretty, but it's a whole lot better than a double dip.
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By Rich Miller in Washington and Brian Grow in Atlanta, with Robert Berner and Michael Arndt in Chicago, and bureau reports |
