How durable is the recovery?

Monday, July 26, 2004
By DANIELLE DiMARTINO
The Dallas Morning News

Durable goods orders are notorious for their volatility. This leads economists to dismiss months that register particularly wide swings.

After all, as economists assure us, one month does not make a trend.

But what about three?

In April and May, durable goods orders fell by 2.7 percent and 1.8 percent respectively, surprising economists to the downside by a good 2 to 3 percentage points each. Another poor showing would mark the first three-month decline since the last recession ended.

"I'll tell you what I'll be watching this week," said John Lonski, chief economist at Moody's Investors Service in New York. "If durable goods orders decline for a third consecutive month in June, I don't think we're going to live up to Alan Greenspan's expectations for the economy."

Wednesday's report will address an issue that's become impossible to ignore.

Has the economy truly weakened, or is the data just a "June swoon," as some economists are calling it?

It may seem counterintuitive that any report takes precedence over Friday's second-quarter gross domestic product. But a third disappointing month of durable goods demand could trigger a downside surprise in the GDP report.

Durable goods demand, after all, is inextricably linked to consumer spending, which accounts for two-thirds of economic growth. A big chunk of the money that's been spent in the current recovery has gone to cars, refrigerators, televisions – in other words, durable goods, which are defined as big-ticket items expected to last three years or more.

At 3 percent, Mr. Lonski's forecast for second-quarter GDP growth lags behind the consensus, which is closer to 4 percent.

"In fact, I wouldn't be surprised if the number came in below 3 percent," he added.

Greenspan's camp

Mr. Lonski represents the minority of economists. Most are confident that June's disappointments merely constitute an aberration in a fundamentally strong trend.

One of the greatest advocates of this view is Federal Reserve Chairman Alan Greenspan. In his testimony to Congress last week, he called the factors that led to the June slowdown "transitory" and characterized the current economic expansion as "broad-based" and "self-sustaining."

Mr. Greenspan has plenty of company.

"I'm more in Greenspan's camp," said James Glassman, senior economist at J.P. Morgan Chase in New York. "There's no doubt the consumer's been hit with higher energy prices, but with energy prices having stabilized, they'll have more cash freed up."

Mr. Glassman said he suspects the Fed chairman would not have been so confident in his assessment, if he weren't sure that positive news was bubbling up.

"If something really bad were happening, we'd be hearing from more businesses that things have slowed down," he added.

Mr. Glassman said he expects a rebound and possibly even upward revisions to prior months in the durable goods report. A survey of economists by Bloomberg News came up with a consensus forecast of 1.5 percent growth.

But it's back to the proverbial drawing board, if the report makes three in a string of disappointments. That would present investors with a puzzle, Mr. Glassman said.

"If we don't see a rebound in durable goods, manufacturing and employment, people will start to draw their own conclusions about the economy," he said.

Missing stimuli

Douglas Kass, general partner at Florida hedge fund Seabreeze Partners, said he has already drawn his conclusions.

"I think we are coming to a difficult transition point for the economy and the markets," he said. "We are entering a world without any stimuli, and we have to face the likelihood that the consumer and profitability are going to disappoint."

The various forms of stimuli, he said, are tax cuts, falling interest rates and mortgage refinancing. The absence of these will weigh on a tapped consumer and reveal to the markets that there is a serious lack of pent-up demand after years of excessive consumption, under this theory.

Mr. Kass holds an extreme view, but his observations are drawn from the same data other market watchers rely on. And the stock market seems to share his attitude these days.

In fact, June 23 marked the most recent high point for the Dow Jones industrial average. Traders aren't blind to the fact that the next day's release of the disappointing May durable goods report coincided with the beginning of a 4 percent retreat in the Dow.

Waiting it out?

Some, though, offer a different opinion on why the stock market seems to be in a funk.

"Sure we've had a slowdown, and part of that is because of the consumer, but it's normal to have a bit of a setback," said Todd Leone, head of listed trading at S.G. Cowen in New York. "But I don't think people are worried about the economy or even earnings.

"What we're hearing is that people are worried about the Democratic National Convention, the Olympics and the election."

If investors wake up to a world free of terrorist attacks after these events, he said, they'll feel more comfortable about being exposed to equities.

Mr. Glassman said he couldn't agree more.

"There's an awful lot of good news out there that's being ignored," he said. "And it's probably because there's so much uncertainty out there. People are saying, 'Why not wait?' "

Even so, if Wednesday's durables report comes in negative, investors could conclude that they've got a more concrete reason to steer clear of stocks.

"Even Alan Greenspan would have to revisit his optimistic assessment of the economy," Moody's Mr. Lonski said.

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