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Recovery May Be Slow, but It's Inexorable

The Fed's caution notwithstanding, evidence abounds that the economy is rolling.

August 17, 2003|Tom Petruno | Times Staff Writer

If this isn't an economic recovery, what is it?

That's a simple question, but it may be the most important one investors should be asking.

Because if you get the big trends right in terms of how your assets are allocated, all other concerns may be of relatively minor importance.

In the late 1990s, the big trend was a rising stock market that reflected a burgeoning faith in the U.S. economy's growth potential and resilience.

From March 2000 through last winter, the big trend was a rejection of risk-taking, especially in the stock market, constant worry that the economy might never get back on a sustainable growth track, and a desire for safety that was most evident in the hunger for high- quality bonds such as Treasury issues.

Since winter, the picture has changed again. There has been much hand-wringing about the economy. But the stock market seems to believe the recovery is real, as share prices overall have rallied and have mostly held on to their gains.

The Treasury bond market also must think the business outlook is vastly improved, given the surge in interest rates since mid-June.

Last week the government provided more evidence that the economy is rolling. July retail sales jumped 1.4% from June, exceeding most estimates. May and June sales data were revised upward.

Those figures belied expectations that consumer spending could be running out of gas. What's more, the government just began in late July to mail child tax-credit checks -- part of the tax cut Congress passed in May. Those checks should help fuel spending this month and in September.

Meanwhile, there was better news on the manufacturing front. U.S. industrial production rose 0.5% in July, the biggest increase since January.

Low business inventory levels suggest that companies have more reason to raise production in the months ahead, said Paul Kasriel, economist at Northern Trust Co. in Chicago.

Likewise, the strong pace of business capital spending in the second quarter should be encouraging to suppliers of capital equipment, such as computers and heavy machinery: The government's measure of capital spending rose at an annualized rate of almost 7% in the April-June period, the fastest rate in three years.

There also has been some upbeat data on employment, which has been the single biggest disappointment in the economy's rebound since 2001. New weekly claims for jobless benefits have been below the 400,000 mark for the last month, down from the 450,000 range in late April.

All of this turned the heads of more than a few economists last week, including some who have been cautious about the growth outlook.

"The data ... are improving rapidly, suggesting that our 3% [annualized] estimate for third-quarter real gross domestic product growth may be too low," brokerage Goldman Sachs & Co. told clients in a report Friday.

At Northern Trust, Kasriel now projects the growth rate will reach 3.8% this quarter and continue in that range through the first half of next year.

That would be a far cry from what the economy achieved in the late 1990s. Even so, it would be a big improvement from the start-and-stop growth record of 2002, following the 2001 recession.

Scott Anderson, economist at Wells Fargo & Co. in Minneapolis, uses an old analogy that still works: the U.S. economy as a huge cargo ship.

"It takes a massive amount of time and stimulus to turn the ship around, but once it's headed in the right direction it will not be easily taken off course again," he said.

At the Federal Reserve, however, optimism about the economy still appears to be in short supply.

At their midsummer meeting last week, Fed policymakers left their key short-term interest rate unchanged at a 45-year-low of 1%. But they said the odds of the economy staying on a sustainable growth track are no better than even. And they continued to cite "the risk of inflation becoming undesirably low" -- an apparent reference to deflation, or a broad decline in prices.

Given their concerns, Fed officials promised to maintain current low short-term interest rates "for a considerable period," which many analysts took to mean six months at a minimum and perhaps as long as one year.

If that was supposed to soothe owners of long-term bonds, it didn't work. The yield on the 10-year Treasury note, a benchmark for other long-term interest rates, ended the week at 4.53%, up from 4.27% a week earlier.

Since mid-June the T-note yield has jumped 1.4 points, albeit from generational lows that many experts said were absurd.

The two-year T-note yield finished last week at 1.81%, up from 1.70% a week earlier.

As for the Fed's concerns about deflation, the government's report Friday on July consumer prices showed a 0.2% rise, the same as June. Those are meager increases, but they still show that more prices are going up than down.

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