March 2001 marked the 10th anniversary of the U.S. economic expansion. In the face of considerable softness in business activity, however, gifts of tin or aluminum now seem more appropriate than crystal or china. While it appears we have avoided an actual recession and have thus reached the 10-year benchmark, observers are wise to be cautious and refrain from celebrating.
Because consumers account for about two-thirds of the U.S. economy, their behavior is a crucial factor in determining how quickly our economy grows. Recent consumer confidence surveys suggest that individuals are reluctant to toast to the economy's progress. Both the Conference Board and the University of Michigan depicted slumping consumer confidence in surveys released in February. While households appear to be relatively upbeat about near-term prospects, they remain concerned about conditions that might be present six months down the road.
Despite these gloomy results, actual buying patterns suggest consumers are not quite ready to leave the party. Auto sales picked up considerably in January and February, and most other retailers reported sales that either met or exceeded expectations. The stock market's slump has reversed some of the earlier wealth gains for consumers, but home prices have continued to rise and lower interest rates have allowed many households to refinance their mortgages at lower costs. Most importantly, despite a number of layoffs, the economy continues to create more job gains than losses and the unemployment rate remains low.
In past economic cycles, the real estate and construction sectors have typically experienced a burst of activity only to fade relatively quickly. This economic expansion has been very different. Housing and commercial real estate remain generally balanced in most regions of the country. Indeed, in January the economy saw gains in the construction of new homes and nonresidential properties.
The manufacturing sector persists as the primary naysayer. Better information systems have caused companies to recognize inventory buildups and cut output faster than ever before. While these cutbacks have been painful, they should be relatively short-lived. Manufacturing and wholesale inventories were already leveling off by the end of December, and the Purchasing Managers¹ Index last month registered its first uptick in a year. Much of the inventory correction in the industrial sector should therefore be completed in the first quarter of 2001. As a result, while real GDP (gross domestic product) will likely eke out a gain of only about 1 percent in the first quarter, performance should improve to about 2.5 percent in the second quarter, with gains of more than 3.5 percent resuming in the second half of the year.
Confidence levels remain the primary risk to the economy's ability to reach another anniversary of expansion. Continued business uncertainty could cause firms to defer spending on capital equipment and new hiring. Consumer uncertainty could prompt households to curtail their spending on housing, cars and other items. However, lower interest rates, faster monetary growth and declining energy prices should provide support. In addition, while Congress may not enact tax cuts soon enough to give the economy an immediate boost, the expectation of lower taxes could strengthen consumer and business confidence. Expected cuts in marginal tax rates, a reduction in the "marriage penalty tax" and an increase in the child-care credit should bolster economic activity in the second half of the year while also providing longer-term benefits
The information provided in this analysis was obtained from sources that Bank of America deems to be reliable; however, we do not guarantee its accuracy or completeness.