LATimes

August 27, 2001

Economy Shows Signs of Hope, Analysts Say Indicators: Falling interest rates and gas prices spur some optimism for turnaround starting this year.

By WALTER HAMILTON, Times Staff Writer

The U.S. economy is beginning to flash signs that it is hitting bottom and that a turnaround could get underway later this year, many forecasters say.

But the signals remain mixed at best, frustrating those hoping for a quick and decisive end to the slowdown that has broadsided the nation in the last year.

And even if a recovery materializes soon, it will be sluggish and almost imperceptible at first, with layoffs continuing to mount, experts say.

Nevertheless, the combination of falling interest rates, reduced energy prices and fortuitously timed tax rebates has stirred hope that the economy will improve before the year is out.

In addition to ongoing strength in home sales and consumer spending, optimists point to falling inventories of unsold goods and slight improvement in the nation's beaten-up manufacturing sector.

Also spurring confidence are a recent moderation in the number of corporate layoffs and an uptick in consumer confidence.

"When you're falling, you have to hit bottom first," said Joel Naroff of Naroff Economic Advisors in Holland, Pa. "Right now, we're hitting bottom. That means we're ready to move forward."

If the economy indeed begins to mend, it could mean a gradual end to a slowdown that has resulted in hundreds of thousands of layoffs, an expected 10% drop in corporate profits and a decline in tax revenue that has wiped out most of the federal budget surplus.

It also could generate a long-awaited rebound in the stock market. And it could help spark a recovery in the economies of other countries, such as Mexico, whose fortunes increasingly are tied to that of the United States'.

However, substantial risks remain, and some experts are convinced the economy already is in recession--not just in a slowdown--and is unlikely to eke out any sort of recovery before mid-2002.

That could be the case in California.

Many economists say the state is in the early part of a slowdown and may hit bottom later than the rest of the nation. UCLA business analysts have predicted that the state will enter a short, mild recession in the second half of the year.

So far, outside of its most tech-dependent areas, California is generally perceived to have held up better than the national economy. And Southern California, with its diverse economic base, has fared better than the northern part of the state.

Still, there are signs that California has been losing momentum. The state's job total shrank by 7,100 in July, following small job gains in previous months.

Whether in official recession or slowdown, the U.S. economy hasn't been this weak since the 1990-91 recession--so long ago that many Americans have forgotten what bad times feel like. The economy is generally considered to be officially in a recession after two straight quarters of falling gross domestic product.

The biggest obstacles to recovery are two intertwined factors: emaciated corporate profits and continuing layoffs. If deepening job losses cause still relatively optimistic consumers to grow timid, the economy could be deprived of its most dependable prop.

Typical of the conflicting signals of recent weeks, the Federal Reserve cut short-term interest rates Tuesday, for the seventh time this year, while warning that economic weakness remains.

But Friday, stocks rallied sharply after Internet equipment giant Cisco Systems Inc. said its business appears to be "stabilizing"--a potentially critical first step that has long been awaited in the ravaged technology sector.

A sizable camp of optimists say the existence of so many conflicting signals is itself a sign of a budding rebound.

When factors that were clearly negative, such as manufacturing, improve to the point that their status is in dispute, a recovery usually is within sight, they say.

"In many respects, this is what these kinds of periods feel like," said Brian Wesbury, chief economist at Chicago-based investment firm Griffin, Kubik, Stephens & Thompson. "Some people say, 'It's darkest before it turns totally black.' But I do believe it's darkest before the dawn."

Economists also say statistics fail to capture the core strength in less visible segments of the economy.

"I haven't seen too many dry cleaners or pizza places going out of business lately," economist Naroff said.

Even some of the more pessimistic forecasters say the second and third quarters of this year ultimately will prove to have been the worst, and that the economy could begin an upturn, albeit a lackluster one, by year-end.

"Arguably, the bottom is behind us," said Jan Hatzius, an economist at brokerage Goldman Sachs Group. "But a dynamic recovery is not going to happen. The risk of recession is still there, but not as large as it was a couple of months ago."

The optimistic argument rests on a number of assumptions.

One is that spending on homes and consumer goods will remain strong, helped in part by the $38 billion in tax rebates arriving in Americans' mailboxes.

Friday, for example, the Commerce Department reported a sharp 4.9% boost in July new-home sales.

Another assumption is that lower interest rates soon will kick-start growth.

There has been concern that the nature of the slowdown, caused largely by falling business investment, means rate cuts won't be as effective as in the past.

Traditionally, recessions are caused by overheated consumer spending, which the Fed quashes by raising rates. As the economy slows and the Fed lowers rates, consumer spending typically resumes.

However, some analysts say businesses whose profits are severely squeezed are far less likely to boost spending regardless of how cheap borrowing costs become.

Optimists scoff at that notion.

"We're in that awkward period where the Fed has eased [rates] aggressively, but because the economy hasn't shown [widely recognized] signs of picking up, people are losing faith," said Mickey Levy, chief economist at Bank of America. "They say, 'Monetary policy doesn't work.' But guess what? It always does."

The summer pullback in energy prices--primarily for gasoline and natural gas--is helping.

Lower energy prices should add an annualized $20 billion to $25 billion to real disposable income in the second half of the year, Goldman Sachs estimates. The average price of self-serve gas is down to $1.43 a gallon nationwide from the May peak of $1.71.

Lower gas prices may be helping Bart Spindler's business.

Spindler said sales at his Sun Valley used-car dealership Auto Jungle plunged in June and July as potential buyers balked after the spike in gas prices. But the dealership, which sells many gas-guzzling sport-utility vehicles, is enjoying its best showing in 18 months, he said.

"My sport-utility business is good again and I don't hear people talking about gas prices. A couple of months ago, they were," said Spindler, who added that it is too soon to tell if the renewed sales will last.

Finally, some analysts say, troubles in some areas are beginning to moderate.

In the devastated manufacturing sector, for example, activity was flat in July after sliding the previous nine months.

Also, inventories of unsold goods have dropped each month since February. That's important because corporations first must unload items sitting on shelves before hiring workers to produce more goods.

On the employment front, the number of workers filing new claims for unemployment insurance has stayed below 400,000 a week for five consecutive weeks, down from the high of 449,000 in early July.

And the so-called index of leading economic indicators, a gauge of likely future conditions, has risen for four straight months.

But pessimists say several factors cast doubt on whether the worst is over.

Lacking so far has been the kind of rally in stock prices that often precedes an economic rebound.

Also, much of the supposedly encouraging data is either tentative, temporary or both, doubters say.

For example, even as the Cisco announcement cheered the stock market Friday, the Commerce Department reported that orders for durable goods such as computers and factory equipment fell 0.6% last month. That shows many businesses continue to slash capital spending.

Corporate profits are expected to take longer than the economy to turn around, meaning companies will lack the wherewithal to spend and hire again.

Meanwhile, a softening world economy is depressing U.S. exports. And some areas of previous vitality, such as commercial real estate, are softening. Those forces prompted the Fed to cut the so-called federal funds rate Tuesday to 3.5%.

Wednesday, the government is expected to trim its estimate of second-quarter GDP, or the total of goods and services produced in the U.S. Earlier figured at a 0.7% annual rate--already the slowest pace in eight years--the revision could show there was no growth at all last quarter, economists say.

Some expect the new estimate to be a negative number. That would mean the economy is contracting--as opposed to simply growing at a much slower pace. It would be a possible first step toward an official recession.

Indeed, many experts say that even if the economy escapes a recession, a recovery will probably be lukewarm.

Historically, layoffs rise even after the economy has begun to rebound, and that dynamic could be even more pronounced in the next year if growth is milder than during past upturns. Indeed, staffing firm Manpower Inc. today will report that only 24% of nearly 16,000 companies surveyed expect to add employees in the fourth quarter, down from 32% in the same quarter last year. Eleven percent said they would cut employment, up from 7% a year ago.

The economy historically has surged more than 5% in the first year of a recovery, said economist Hatzius of Goldman Sachs. But his firm projects only 2% growth next year and 2.5% in 2003 as the overhang of the capital spending bust inhibits growth.

"It's a recovery that will see unemployment rising until the end of 2002," Hatzius said.

-- Anonymous, August 27, 2001