"U.S. Recovery May Start, Then Sputter as Zarnowitz Rule Is Bent
By Rich Miller and Matthew Benjamin
May 11 (Bloomberg) -- The Zarnowitz rule may live, but not for long.
The current contraction may so far be following the economic law named for Victor Zarnowitz, the late expert on business cycles: Deep recessions are almost always followed by rapid rebounds. Consumer confidence rose by the most in more than two years in April as surging stock prices and falling mortgage rates boosted optimism. A gauge of U.S. manufacturing activity had its biggest bounce since 2005 as companies eased up on efforts to slash inventories. Even the crippled housing market has shown signs of stabilizing.
The risk is that any snapback may end up stunted by structural impediments -- from heavily indebted consumers to a hobbled banking system -- that continue to weigh on the economy and may prevent a sustained run of rapid expansion.
“We could see one or two quarters of 6, 5, 4 percent growth,” says Joel Naroff, president of Naroff Economic Advisors Inc. in Holland, Pennsylvania, who was the top forecaster of the U.S. economy in Bloomberg News surveys last year. “But that doesn’t mean that the economy will be in good shape. We’ll just be going from truly gruesome to bad.”
Bridgewater Associates agrees. The Westport, Connecticut- based financial firm, which says it manages $72 billion in assets, sees a good chance of a big spurt in the economy late in the year, with growth then settling back to a trend line of a shade over 2 percent. That would be well below the postwar rate of 3.3 percent.
The economy shrank at an annual pace of 6.1 percent in the first quarter after contracting by 6.3 percent in the previous three months, the weakest six-month performance since 1957-58. Inventory cutbacks alone accounted for 2.79 percentage points of last quarter’s decline, as businesses slashed stockpiles at the fastest pace since government records began in 1947.
That has some economists expecting a fillip when companies ramp output back up after reducing unsold supplies to desired levels. If the increase is concentrated in a short period of time, the impact on growth in any given quarter might be significant.
“An important influence on the near-term economic outlook is the extent to which businesses have been able to shed the unwanted inventories,” Federal Reserve Chairman Ben S. Bernanke told lawmakers on May 5. “As stocks move in better alignment with sales, a reduction in the pace of inventory liquidation should provide some support to production.”
That may already be happening at some companies. Toyota Motor Corp. is boosting the speed of a Camry assembly line in Georgetown, Kentucky, and is scheduling overtime at a factory building RAV4 sport utility vehicles in Woodstock, Ontario, as stockpiles ran low following previous output cuts.
Housing is another area that may prove to be a surprise source of strength. Homebuilding began to buckle in 2006, chopping 1 percentage point from annual economic growth ever since. As the market stabilizes, that drag will dissipate, giving the economy a short-term boost.
“Housing looks like it has bottomed,” says Allen Sinai, chief economist at Decision Economics in New York.
Confidence among homebuilders rose in April to its highest level since October as record-low mortgage rates below 5 percent started to stir demand. Prices for home resales in March posted their biggest monthly gain since June 2005, with some regions seeing multiple bids on properties.
‘Seeing a Floor’
In southern California, one of the hardest hit areas, prices have begun to stabilize, according to KB Home Chief Executive Officer Jeffrey Mezger. “We’re seeing a floor,” he said in a May 4 call with analysts. That’s giving the Los Angeles-based company an opening to sell newly built homes.
The economy will also get a lift from President Barack Obama’s $787 billion stimulus package of spending increases and tax cuts, which was signed into law in February and is only now starting to kick in. While Federal agencies have allocated $88.1 billion of investment, so far just $28.6 billion has been spent.
Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm, says consumers will also benefit this month from some $13 billion in extra Social Security payments.
That leads Michael Mussa, a former chief economist of the International Monetary Fund, to argue that the U.S. will enjoy a so-called V-shaped recovery. Mussa, who’s now at the Peterson Institute for International Economics in Washington, invokes Zarnowitz in saying “there is no good reason to presume” that this recovery won’t be a strong one.
Zarnowitz, a native of Poland, fled the Nazis in 1939 only to end up in the Soviet gulag. After making it to the U.S. in 1952, he became a professor of economics at the University of Chicago and a leading expert on business cycles and economic indicators. He joined the National Bureau of Economic Research in 1952, where he was one of the seven economists who date recessions and expansions. He died in February at age 89.
Many economists, including Naroff, disagree with Mussa. David Rosenberg, former chief North American economist at Bank of America and now chief economist at Gluskin Sheff & Associates Inc. in Toronto, says the current contraction isn’t a typical, inventory-driven recession: “This is a deleveraging cycle.”
Consumers are still saddled with hundreds of billions of dollars in debt built up during the boom years when home prices skyrocketed. As a percentage of net worth, household debt -- which includes mortgages -- stands at 27 percent, the highest on record, according to John Lonski, chief economist at Moody’s Capital Markets Group.
Americans have also seen their wealth walloped. U.S. house prices rose 63 percent from 2002 to June 2006 and then fell 27 percent since that peak, according to national Case-Shiller data. The Standard & Poor’s 500 index hit a 12-year low in March and now stands 42 percent below its October 2007 peak.
As a result, households are being forced to save more and spend less. Lyle Gramley, a former Fed governor who is a senior economic adviser for New York-based Soleil Securities Corp., sees the savings rate rising to 7 to 8 percent over the next few years from an average of 1.7 percent during the past decade.
An added reason for restraint: the continued rise in unemployment, which climbed to a 25-year high of 8.9 percent in April from 8.5 percent in March.
Banks have also turned more cautious after piling up close to $1 trillion in lending and investment losses during the last two and a half years. A Fed survey released May 4 found that banks toughened terms on home and credit-card loans in the past three months.
According to stress tests carried out by regulators, the nation’s biggest banks need $74.6 billion in additional capital to be able to weather a further worsening of the economy and keep on lending.
“The biggest financial crisis in 70 years is likely to leave a legacy with consumers, business people and investors,” says Richard Berner, co-head of global economics for Morgan Stanley in New York. That “will have an impact on the kind of economic activity and the kind of rebound we’re likely to get.”