The Timing and Scope of the 2002 Rebound Michael R. Englund Chief Market Economist Standard &...

The Timing and Scope of the2002 Rebound

Michael R. EnglundChief Market Economist

Standard & Poor’s

March of 2002

Summary

Business investment fell sharply in the 2001 recession:•Equipment spending plummeted•Inventories collapsed at an unsustainable rate•U.S. “exported” factory weakness through trade

Household and government spending remained robust:•Negative wealth effect never materialized•Housing and government sectors grew briskly

Conditions are in place for a healthy expansion•Inflation is under control, and interest rates are low•Yield curve is pricing-in healthy growth

Part One:

The Factory and Tech-Sector Collapse

*Shipments of computers and electronics plummeted after December of 2000 to an extremely weak low, but are now turning higher.

Shipments of Computers and Electronics [in Blns of Dollars]

$20

$25

$30

$35

$40

$45

$50

Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02

*The sharp gyration in the technology sector prompted a similar pattern for total domestic expenditures on capital goods overall.

Domestic Nondefense Capital Goods Shipments (Adjusted for Net Exports of Capital Goods)

[in Blns of Dollars]

$35$40

$45$50$55

$60$65$70

$75$80

Jul-92 Jul-94 Jul-96 Jul-98 Jul-00 Jul-02

•The construction component of business investment tracked the equipment sector downward after peaking in Q1 of 2001, and could remain sluggish.

Real Comercial Construction [in Blns of '92 Dollars]

$110

$125

$140

$155

$170

$185

Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02

*The result of the drops in the two business fixed investment components was a much larger component contraction than seen in the 90-91 recession.

Business Fixed Investment Growth

-16%

-8%

0%

8%

16%

89/Q1 91/Q1 93/Q1 95/Q1 97/Q1 99/Q1 01/Q1

Actuals in BlueEstimates in Red

•The downturn in business inventory investment was even more severe, with an unprecedented collapse in Q4 following the events of 9-11.

Quarterly Change in Real Inventories

($125)

($100)

($75)

($50)

($25)

$0

$25

$50

$75

$100

89/Q1 91/Q1 93/Q1 95/Q1 97/Q1 99/Q1 01/Q1

Bln

of 1

99

2$

Actuals in BlueEstimates in Red

•The annual inventory figures reveal the unusual size of the cumulative 2001 inventory collapse, versus the prior three downturns.

Annual Change in Real Inventories

-$70

-$35

$0

$35

$70

1973 1977 1981 1985 1989 1993 1997 2001

Billio

ns

of

19

92

$

•Inventory-to-sales ratios were typical for a recession until September, when the ratios went into a powerful freefall, with sales strength but output weakness.

Inventory-to-Sales Ratio for All U.S. Businesses

1.31

1.36

1.41

1.46

1.51

1.56

Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02

*Gross investment, which combines fixed and inventory investment, as well as corporate profits, are now turning upward after a sharp downturn.

Growth in Gross Investments Vs. Profits

-34%

-17%

0%

17%

34%

74 Q1 77 Q1 80 Q1 83 Q1 86 Q1 89 Q1 92 Q1 95 Q1 98 Q1 01 Q1

Gross Investment Profit Growth

*Both exports and imports of goods have fallen sharply from a Q3, 2000 peak.

Imports and Exports of Goods ($Blns, SA)

$30

$50

$70

$90

$110

Jul-89 Jul-91 Jul-93 Jul-95 Jul-97 Jul-99 Jul-01 Jul-03

Imports Exports

*The export slowdown was concentrated in capital equipment, which is a volatile sector in which the U.S. has a comparative advantage.

Goods Exports: With & Without Capital and Aircraft

-24%

-12%

0%

12%

24%

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02

Goods Exports: Total Goods Minus Capital Equip Goods Minus Aircraft Exports

*The import slowdown was, at first, also concentrated in capital equipment,As the U.S. successfully pushed sector weakness abroad through trade.

Goods Imports: With & Without Capital Goods

-33%

-22%

-11%

0%

11%

22%

33%

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02

Goods Imports: Total Goods Minus Capital Imports

*A trade price freefall is a big part of the “global” goods sector downturn.

Merchandise Import and Export Prices

89

93

97

101

105

109

Jul-89 Jul-91 Jul-93 Jul-95 Jul-97 Jul-99 Jul-01 Jul-03

Imports Imports Ex-Oil Exports Exports Ex-Ag

*The trade price freefall also reflects a reversal in oil prices, which is a reason why it may come to an abrupt end if there is turmoil in the Gulf.

WTI Oil Price: Nominal and Real Dollars

$0

$10

$20

$30

$40

$50

$60

$70

$80

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002

Nominal $ Real 2000 $

*But falling trade prices also reflect a soaring U.S. dollar, and an economic rebound should only exacerbate this upward trend.

The Trade-Weighted Dollar

75

85

95

105

115

125

135

Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01

Part Two:

Household and Government Sectors Remain Solid

*Hardly any slowdown was seen in U.S. consumption growth, and this component accounts for two-thirds of GDP.

Quarterly Growth in Real Consumption

-4%

-2%

0%

2%

4%

6%

89/Q1 91/Q1 93/Q1 95/Q1 97/Q1 99/Q1 01/Q1

Actuals in BlueEstimates in Red

*U.S. consumption growth closely tracks disposable income growth, though the relationship was distorted by the Q3/Q4 gyrations in tax rebates.

Growth: Consumption Vs Disposable Income

-8%

-4%

0%

4%

8%

12%

Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03

Consumption Disposable Personal Income

*The mismatch of consumption and income growth is observed in the savings rate. Here, the downtrend has only stalled modestly since 2000, if we ignore the “tax rebate” distortion.

U.S. Savings Rate

0%

2%

4%

6%

8%

10%

Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02

*The sharp drop in Asset prices in 2001 exacerbated the presumed “negative wealth” effect, though we now expect a rebound in asset values.

Nominal Growth in Total U.S. Household Assets and Liabilities

-5%

0%

5%

10%

15%

20%

25%

1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002

Assets Liabilities

*Net worth grew at a 9%-14% rate in each of the five years prior to 2000, before slowing sharply in 2000 to –1% and an estimated -5% in 2001.

Nominal Growth in Total U.S. Household Net Worth

-5%

0%

5%

10%

15%

1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002

*The ratio of net worth to nominal GDP soared from 1994 to 1999 because of the huge gains in “real” terms, before plummeting through 2001.

Ratio of Total Assets to Nominal GDP

3.3

3.5

3.7

3.9

4.1

4.3

4.5

4.7

4.9

5.1

1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002

Breakdown of U.S. Household Assets, at the End of 2001 Total U.S. Household Assets: $48,396 Bln

Real Estate $13,264 27% Consumer Durables $2,914 6% Deposits $4,967 10% Credit Market Instruments $1,894 4% Corporate Equities $5,832 12% Noncorporate businesses $5,105 11% Pension Funds $8,723 18% Mutual Funds $2,993 6% Other $2,704 6%

*Total stock market exposure is roughly 40%.

*The housing sector has remained remarkably resilient to events elsewhere, and fiscal and monetary stimulus should boost this sector through 2002.

Housing Starts (in Millions)

0.8

1.0

1.2

1.4

1.6

1.8

Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02

*Construction is heavily skewed toward the southern states, though activity in all four regions remains healthy due to falling interest rates.

Housing Starts by Region (1000's)

0

100

200

300

400

500

600

700

800

900

Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02

Northeast Midwest South WestSeries4 Series5 Series6 Series7

•Stimulative effects of the 2001 tax cuts were already kicking-in when the war on terrorism provided a hefty boost to spending prospects.

Quarterly Growth in Real Gov't Purchases

-6%

-3%

0%

3%

6%

9%

89/Q1 91/Q1 93/Q1 95/Q1 97/Q1 99/Q1 01/Q1

Actuals in BlueEstimates in Red

•Accelerating federal government spending will sharply boost total government spending through 2002 and 2003, alongside tax cuts.

Annual Growth in Real Gov't Purchases

-2%

-1%

1%

2%

3%

4%

5%

6%

7%

1973 1977 1981 1985 1989 1993 1997 2001

Part Three:

Conditions are in PlaceFor a Healthy Expansion

*Inflation rose at the end of the last expansion, but then slowed sharply with with plummeting energy prices and slower economic growth.

Inflation in the Last Five Recoveries

0%

5%

10%

15%

0 12 24 36 48 60 72 84 96 108 120 132

91 Recovery 82 Recovery 80 Recovery75 Recovery 70 Recovery 61 Recovery

During Each Expansion and Ensuing Downturn

Months After Trough

*Continued firmness in core inflation is troublesome, but this partly reflects the lagged impact of the earlier surge in energy prices, and general lags in the relationship between inflation and the business cycle.

CPI Versus Core, Y/Y Growth

0%

1%

2%

3%

4%

5%

6%

Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03

CPI Total CPI ex-Food & Energy

*Wage inflation is finally moderating, and the rising unemployment rate should have ongoing beneficial effects on wage price pressure through 2002.

Unemployment Rate & Hourly Wage Growth

2%

3%

4%

5%

6%

7%

8%

Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03

Average Hourly Earnings Unemployment Rate

*Total employment costs accelerated sharply through 1999 and early-2000, but the run-up paused in 2001, and should moderate somewhat in 2002.

ECI Gains: Total, Wages, and Benefits

1%

2%

3%

4%

5%

6%

7%

1987 1990 1993 1996 1999 2002

*The Fed funds rate revealed an unusually large cyclical drop as the economy slowed, and this provided a big pre-emptive boost to GDP growth in 2002.

Fed Funds Rate in the Last Five Cycles

0%

5%

10%

15%

20%

0 12 24 36 48 60 72 84 96 108 120 132

91 Recovery 82 Recovery 80 Recovery75 Recovery 70 Recovery 61 Recovery

During Each Expansion and Ensuing Downturn

Months After Trough

*On both a nominal and inflation-adjusted basis, the “real” Fed funds rate has been cut sharply over the past year.

Real and Nominal Fed Funds Rate

-6%

-3%

0%

3%

6%

9%

12%

15%

18%

Jan-55 Jan-62 Jan-69 Jan-76 Jan-83 Jan-90 Jan-97

Nominal Rate Real Rate

* Treasury yields at the short end of the curve fell sharply with Fed easing. But yields on longer dated securities fell by less, and yields on corporate bonds and mortgages hardly fell at all.

Assorted Market Yields, vs 2, 5, 10-Yr Treasuries

2%

3%

4%

5%

6%

7%

8%

9%

Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01

AAA BBB S&L's Mortgages 2-Yr 5-Yr 10-Yr

*Yield curve inversions have been a powerful predictor of recessions with a 9-20 month lead, and we had two inversions in 1998 and 2000. Since then, the curve has steepened dramatically as usually occurs in an expansion.

Funds Rate and Treasury Long Bond Yield

PS

P

SP

S

P

S

P

SS

PS

S

0%

5%

10%

15%

20%

Jan-59 Jan-65 Jan-71 Jan-77 Jan-83 Jan-89 Jan-95 Jan-01

Fed Funds Rate Treasury Long Bond Yield

“S” = Inversion “Signal”“P” = Cyclical Peak

Summary

Business investment fell sharply in the 2001 recession:•Equipment spending plummeted•Inventories collapsed at an unsustainable rate•U.S. “exported” factory weakness through trade

Household and government spending remained robust:•Negative wealth effect never materialized•Housing and government sectors grew briskly

Conditions are in place for a healthy expansion•Inflation is under control, and interest rates are low•Yield curve is pricing-in healthy growth