Lynn Reaser: Technology, Software, Industrial Equipment Showing Strength

by: Harlan Levy

Lynn Reaser is president of the National Association for Business Economics and chief economist of Point Loma Nazarene University in San Diego. Previously she was managing director and chief economist for the Investment Strategies Group at Bank of America.

Harlan Levy: Was the Gross Domestic Product report – the weaker than expected 2.4 percent growth in the second quarter – and the tepid consumer confidence number good or bad news for the U.S. economy?

Lynn Reaser: The number on GDP was on the soft side on the surface, but below the headline the economy actually showed significant strength. The consumer confidence index was revised upward for July although it was lower than in June.

The 2.4 percent rate is certainly not enough to make a dent in unemployment, although growth overall for the first half of this year was a relatively good 3.1 percent, and a 3 percent growth rate is likely to be achieved in the second half of this year.

There were a couple of areas of slow growth in the second quarter. Consumers remain very cautious, and the savings rate jumped to 6.2 percent, which is a seven-year high. State and local government budget strains limited their gains, but outside of those two areas we saw very strong increases in spending. Business investment continued to soar. Companies, particularly large firms, were buying new computers, software, industrial equipment, and cars, trucks, and airplanes.
Companies also continued to rebuild inventories.

Housing showed a sizeable jump. Federal spending posted a further rise, and even commercial building increased during the quarter, although the commercial real estate sector remains the most depressed area with little relief for another one or two years.

H.L.: Corporate earnings have been strong, and as you said, business spending in the second quarter rose -- by double digits. Don’t these data point to strong future hiring, which the economy needs to get out of the doldrums?

L.R.: We would hope so, but companies are still reticent to ramp up staffing. There have been recent concerns about Europe, which seem to be subsiding. However, firms, particularly smaller companies, remain wary over the possibility of a future slowing in the economy. They are worried about the implications of a growing federal debt, and they are uncertain about future health care and energy costs and taxes.

H.L.: If the Bush tax cuts for the wealthy are allowed to expire, will that have much effect on the economy?

L.R.: Wealthy households represent a significant amount of spending in the U.S. economy, so there could be some impact on overall economic activity. There could be a bigger impact if the tax rates on capital gains and dividends were raised, although the Obama administration indicated that this is not their recommendation.

H.L.: The poor job numbers, weak housing activity, and anemic retail sales haven’t abated, so do you expect a sluggish second half of this year as well as next year?

L.R.: We probably have enough strength in business spending and other parts of the economy to support around 3 percent growth. Weaker business confidence could lower that number, while stronger business confidence could spark more hiring which could raise the number.

H.L.: What’s your prediction for the stock market and its volatility in the second half?

L.R.: I think we will see continued very high volatility and probably a further rise in equity prices, because of continuing increases in profits, driven in part by further gains in international sales.

H.L.: After an oversold stock market in June and negative economic reports, July saw a stock market boom, while the massive deficit kept growing. Some see a similarity with what happened in the Great Depression. What do you think?

L.R.: The current economy is nothing on the order of the Great Depression. This recession lasted 1 ½ years, while the Depression lasted four years. The unemployment rate in this downturn peaked at 10 percent, and in the Great Depression it topped out at 25 percent.

H.L.: Is deflation a real concern?

L.R.: It is a risk, but at this point we still see only modest inflation, not deflation. Prices are rising at a 1 to 1 ½ percent pace, and they’re not declining.

H.L.: What do you think of those in Congress who are pushing drastic cuts in spending and the deficit right now as opposed to continued spending to get us out of the sluggish economy?

L.R.: Now is not the time to be raising taxes, as that would be the most injurious force to the U.S. economy. It is critical, however, to restore confidence on the part of businesses and consumers that we have a plan to reduce the deficit in the future.

The best set of economic policies, therefore, would be not to increase spending at this time or make cuts in spending, or to raise taxes, but we need to have a plan in place so people are assured that the deficit won’t continue to grow but will shrink over time.

H.L.: What sectors of the economy seem strong and which ones seem weak?

L.R.: The real powerhouse of this economy involves business investment, including spending on technology, software, industrial equipment, and a broad base of rebuilding inventories.

On the weak side, retailers are still struggling in face of a consumer who seems to be up and down and very cautious. Commodity producers are also in the throes of a boom-bust cycle, with China trying to slow its economy and achieve a soft landing.

Disclosure: No positions