online.wsj.com
GDP Data Spark Hopes Recovery Is Strengthening
By JON E. HILSENRATH
Staff Reporter of THE WALL STREET JOURNAL
Hopes for a more-robust economic recovery got a boost as the nation's major engines for growth -- the federal government, business community and consumers -- accelerated their pace of spending in the second quarter.
By far, the biggest development in a string of upbeat economic indicators was the release of the latest report on gross domestic product, the total value of the nation's output of goods and services. The Commerce Department said GDP grew at an annual rate of 2.4% during the second quarter, a period when the nation was at war with Iraq, which many believed would be a drag on the economy.
That was the strongest performance for the economy since last summer and was notably better than the consensus estimate for a 1.6% growth rate. It also was an acceleration from the 1.4% rate that prevailed during the previous six months.
Much of the increase in second-quarter growth came in defense spending, which soared at a 44% annual rate after shrinking in the three months leading up to the war against Iraq. It was the fastest quarterly pace of defense spending since the Korean War more than 50 years ago.
The overall pace of growth was still too slow for any pickup in hiring -- due in part to reductions in inventories and surging imports. But economists said it showed that business activity was taking a turn for the better after a long period of near stagnation. "This is a precursor to an improvement in activity down the road," said James Glassman, an economist with J.P. Morgan Chase.
Treasury Secretary John Snow said the economy is well on its way to recovering. He said he expects gross domestic product to increase to 3.5% in the fourth quarter and 4% next year. "And we haven't even yet seen the full effects of the tax bill -- add the momentum that's already there and I think we're going to have some much better results to report in the third quarter and fourth quarter."
The sharp increase in military spending largely reflects the unexpectedly high cost of the war, especially the refurbishment of tanks, airplanes and other equipment. Military spending is likely to remain strong for the rest of the year, but not at the elevated levels witnessed in the second quarter, says Loren Thompson, a defense analyst at the Washington-area Lexington Institute. The Pentagon has said it is now spending about $4 billion a month for Iraqi operations, apart from money used to rebuild the country.
While the pace of military spending might not be sustainable, other segments of the economy also showed signs of vitality, helped by the lowest interest rates in a generation. There had been fears that the war would hurt consumer confidence and hold back spending, but consumer spending accelerated to the fastest pace since last summer. Investment by businesses, bouncing back after years of retrenchment, grew at the fastest rate in three years and construction spending was stronger than almost anyone expected.
All of this is contributing to a spreading sense of optimism about the economy. Stock prices rallied, with the Dow Jones Industrial Average climbing more than 160 points before giving up much of those gains late in the session. Rising stock prices could reinforce the recovery, by making business executives and individuals more confident about spending.
The dollar's recent surge against other major currencies also gathered pace.
However, the financial markets also carry a risk to the burgeoning pickup in growth. Bond prices, which tend to react negatively to growth, pushed lower, continuing a startling six-week rout (see article). Yields on 10-year Treasury bonds rose to more than 4.4%, their highest level in a year. Some analysts worry that rising interest rates could slow the pace of recovery, by making it harder for households to refinance their mortgages and increasing the cost of borrowing for businesses.
"It is a Molotov cocktail for the bond market to have these kinds of figures," said Edward McKelvey, a Goldman Sachs economist.
Underscoring the improving economic outlook, the Labor Department reported that the number of Americans filing first-time claims for unemployment benefits fell to 388,000 in the week ending July 26. It was the second consecutive week that jobless claims held below the critical 400,000 level.
"No matter how you slice it, this run of data points to the American economy accelerating as we move into the second half of the year," says Neal Soss, chief economist at Credit Suisse First Boston.
Adding to the drumbeat of positive economic news, several major companies reported solid profit results. Procter & Gamble Co., for instance, reported a 5% gain in net income (see article). Exxon Mobil Corp.'s net rose 58%, topping Wall Street estimates despite a drop in crude-oil prices (see article).
Meanwhile, the Chicago Purchasing Managers Index, a measure of manufacturing activity in the Midwest, jumped to 55.9 in July from 52.5 in June, well above estimates and the best reading since January.
In conference calls with analysts, some business leaders are expressing subtle improvements in their outlooks and plans that reflect that. "While we are still cautious about the outlook for economic growth, we plan to increase our spending on business-building initiatives during the second half of the year," Kenneth I. Chenault, chairman and chief executive of American Express Corp. said earlier this week.
The latest GDP figures offered some positive signals about the outlook for business spending. Business fixed investment rose at a 6.9% annual rate, the fastest pace since the second quarter of 2000, well before the recession of 2001 set in. That increase included a 7.5% annualized increase in investment in equipment and software -- most notably in computers -- and also was the fastest investment rate in three years.
But while business investment is starting to pick up, it is still about $100 billion off the pace of spending that prevailed in 2000, according to Mr. Soss. "There is still plenty of slack in the economy," he said.
Moreover, while spending on new equipment has been picking up, businesses pared inventories at an $18 billion annual rate during the second quarter, effectively holding back production and using or selling products off their shelves. J.P. Morgan's Mr. Glassman described this as a sign of lingering executive caution. With inventories now especially lean and consumer spending possibly accelerating, he said he expects businesses to stock up in the months ahead, adding to economic output.
Among the businesses that fared best in the second quarter were defense contractors, in step with the rapid rise in military spending. Lockheed Martin Corp., the nation's No. 1 defense contractor, saw revenue rise 23% to $7.71 billion in the second quarter. Raytheon Co.'s second-quarter revenue rose 8%. At Northrop Grumman Corp., revenue rose 56% from a year earlier.
On the consumer side of the economy, spending on automobiles accelerated again, lifting overall consumption to a 3.3% spending pace, the fastest rate since a similar spurt in car sales during the third quarter of 2002. Household spending on cars has taken on a saw-tooth pattern ever since the Sept. 11 terror attacks, driven by the timing of low interest-rate dealer financing programs.
But another factor holding back growth during the second quarter was in the nation's trade position. The Commerce Department said that imports of goods rose at a 16% rate during the second quarter, the fastest pace in a year. Imports of services declined but the overall level of imports was still up at a 9% rate while exports -- hurt by weak economies abroad -- declined. The increase in imports means that while consumption by American households is on the rise again, the gains are not always helping American producers.
Some economists are hoping that a weaker dollar -- which is down from a year ago -- and stronger growth abroad will reduce this drag in the months ahead.
--Bob Davis contributed to this article.
Write to Jon E. Hilsenrath at jon.hilsenrath@wsj.com
Updated August 1, 2003 4:41 p.m.
KJC |
