Photo: Flickr / mhaithaca
After a big spring, Zach Atya thought the Solstice Sunglass Boutique would have a boffo summer.Instead, July sales at the McLean, Va., store are 7 per cent short of its target, even with promotions.
“People are shopping around and comparing prices,” said Atya, the store’s assistant manager. They’re “uncomfortable with spending money now.”
When the job market began to crack in April, most economists said they weren’t worried about the recovery. They’re worried now.
As the recovery slows, optimism is giving way to caution, with undercurrents of something darker. Economic forecasts are coming down all over Wall Street: Goldman Sachs and Deutsche Bank both cut forecasts of second-quarter growth to just over 1 per cent.
Companies from chipmaker Intel to Morgan Stanley have missed or lowered earnings forecasts — 99 companies in the Standard& Poor’s 500 lowered second-quarter projections. In June, 22 of 30 U.S. economic data reports also missed forecasts, Merrill Lynch said.
“We’re worried about growth slowing down everywhere, and about it being self-reinforcing,” said Peter Fisher, global head of fixed income for Black Rock, the world’s largest asset manager. “I’m less worried about whether growth is slowing, and more worried about how much farther we have to go.”
It could get much worse if we hit the “fiscal cliff”: A combination of expiring tax cuts and slashed federal spending set for Dec. 31 would cut the federal budget deficit by an amount equal to 4 per cent of U.S. gross domestic product, throwing millions of people out of work if Congress doesn’t stop them. Many economists think even a compromise that extends some tax cuts and reduces or delays spending cuts could reduce growth.
Three years into its recovery, the economy is once again on a rough road. Gross domestic product — the leading barometer of the nation’s economic health because it measures the value of all goods and services made in the U.S. — equals consumer spending plus business investment plus government outlays, less the trade deficit. And all four are in trouble.
Since 1990, unemployment has generally fallen when growth is 2.5 per cent or better. As growth has stalled this year, so has the improvement in unemployment, now stuck at 8.2 per cent. And as Federal Reserve Chairman Ben Bernanke told Congress last week, reining in the budget deficit too fast at year’s end could cost 1.25 million jobs.
“It’s about fear and uncertainty,” said Mike Collins, a bond portfolio manager at Prudential Fixed Income. “When corporations have uncertainty, they cut back hiring and they cut capital spending. It feels like that’s what’s happening.”
What’s hurting consumption? A shortage of good-paying jobs for one. Just ask Janet Beaman.
The 61-year old from Manassas, Va., was a mortgage underwriter until losing that job in 2007 as the housing market began to fracture. She became a security guard for half the pay. Then her tight budget took another hit when her hours got cut several months ago.
Nights out have been traded for movies at home, and her 13-year old Jeep Cherokee is being asked to keep rolling. She went back to college to upgrade her skills, and $800 a month in student-loan payments begin next month.
“The big night is if we go through the drive-through” at a fast-food joint, Beaman said. “I pray every day, ‘Let me drive this car a little longer.'”
As gas prices have risen and fallen this year, the job market has been the best predictor of consumer spending, which made up 71 per cent of last year’s GDP. When the U.S. was adding an average 225,000 jobs a month in wintertime, discretionary spending on clothing, cars and restaurants rose at double-digit rates despite more-expensive gas.
Now, with gas cheaper than two months ago, the needle is moving the other way as job growth has averaged about 75,000 the past three months. Furniture, home improvement and electronics are being hit especially hard. Overall, consumer spending grew 2.5 per cent in the first quarter — faster than the overall economy. From April to June, that may have grown by as little as 1.1 per cent, consulting firm IHS Global Insight says.
Investment and trade
Until April, investment looked like pretty much the best thing in the economy. It still does — it’s just that the distinction means less and less.
Investment is only 13 per cent of the economy, but it’s central to boosting productivity and jobs. Companies boosted spending on new equipment and software — the biggest class of investment — by 10 per cent last year but only 3.5 per cent in the first quarter. That’s one-fourth of the late-1990s pace. Investment in commercial buildings and structures grew less than 1 per cent the past six months, after jumping nearly 15 per cent in 2010.
The future, if anything, looks worse.
Nearly half of corporate economists expect their companies’ capital spending to stay the same over the next 12 months, according to a new survey by the National Association of Business Economists. Only one in eight think it will climb 10 per cent. The share of businesses reporting higher capital spending has fallen by half since December, the association said.
One reason investment is weak is that trade partners in Europe are in bad shape. The trade deficit takes only about two-tenths of a point off of growth this year, according to Merrill Lynch, but blips in exports hurt high-profile companies. One example is Ford Motor, whose unit sales rose 7 per cent in the U.S. in the first half — but fell 10 per cent in eurozone nations, including 16 per cent in June.
Capital spending depends on business confidence, which is falling for lots of reasons. Some small-business people even blame heath care reform: Steve Diels, whose Los Angeles-based Aamcom runs answering services for doctors, has curbed hiring and investment because he fears small medical practices will be squeezed by the law.
“We’re not going to hire until we know we can grow,” Diels said.
Bob Stevens knows his way around Washington. The chief executive of Lockheed Martin is responsible for 93 lobbyists, and Lockheed’s political-action committee has given $2.8 million in contributions since 2010.
On Capitol Hill last week, Stevens said year-end budget cuts will make him lay off 10,000 people â€” and are already making Lockheed cut investment and hiring. The fiscal cliff will also force layoffs and furloughs for everyone from FBI agents to people who process Social Security claims if Congress doesn’t act, he said.
“Tragically, we can’t reliably estimate how many people will be affected,” Stevens told a House committee. “How many family lives are going to be disrupted?”
Already, government spending is one of the economy’s weakest parts. Since 2010, state and local governments have cut 400,000 workers, including 225,000 educators. Government’s shrinkage has reduced GDP at an annual 0.8 per cent clip for the last six months.
That’s all before $1 trillion in “fiscal cliff” cuts, split between national security and the rest of government. President George W. Bush’s 2001 and 2003 tax cuts, and President Obama’s 2010 payroll tax cut, also expire Dec. 31.
Indeed, a newly hot debate is whether the fiscal cliff is already slowing the economy. One who thinks it is: Ethan Harris, co-chief economist for Merrill Lynch. Some companies may be expecting less government business, some people might save money to pay more taxes next year, and others may anticipate that their customers will be poorer. No one really knows, he said.
“The cliff matters this year because it’s a huge uncertainty shock,” Harris said. “Both corporations and consumers have incentives to delay spending.”
A full-bore rush off the fiscal cliff would equal a recession, Moody’s Analytics said last week. Even a compromise would push America close to recession, Merrill Lynch’s Harris said. He thinks the economy would grow 3 per cent in 2013 with no policy changes, and a compromise package of spending cuts and tax increases will cut that to 1 per cent. .
“The tax increases and spending cuts slated to hit next year equal more than 4.5 per cent of GDP,” Moody’s chief economist Mark Zandi wrote. “An economy growing at 2 per cent can’t withstand this.”
A way out?
With all the disappointing economic news, stock investors stayed fairly optimistic — at least until another round of selling on Friday. But interest rates moved to a new all-time low, a now-familiar sign investors are buying U.S. Treasuries as a haven.
Markets don’t trust Congress to manage the economy, and investors think that while the Fed may do another round of bond-buying to stimulate the economy, Fed action alone isn’t enough, Merrill Lynch’s Harris said.
“The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery,” Bernanke testified last week:
“Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.”