The State of the Economy Is ... Fragile

Jan. 28, 2003 -- The America that President Bush addresses tonight is economically weaker than it was one year ago.

In the months following the Sept. 11 attacks, the administration, as well as economists from both sides of the political fence, favored the phrase "remarkably resilient" when describing the U.S. economy.

There was plenty of evidence to support that. The United States had been in a recession from January through September of 2001, but thanks to a strong surge of home refinancing and auto sales, the economy began to grow again in the final months of that year.

So a year ago, economic growth was strong, with the gross domestic product at 5 percent. But then after moderate growth in the middle of the year, the economy hit what the Federal Reserve has described as a "soft spot."

We'll find out just how little the economy grew in the final three months of 2002 this Thursday, when the Commerce Department releases data on the fourth-quarter gross domestic product. Economists have been revising down their forecasts and now believe the economy grew as little as 0.6 percent — not a strong showing by any measure.

How Now Dow?

The last time President Bush gave his State of the Union, the benchmark Dow Jones Industrial Average was at 9,840. Today, despite pushing into the 10,000 range in the spring, the Dow hovers around 8,000 as investors remain preoccupied with talk of an imminent war and by lowered guidance from corporations.

In 2002, the Dow was down for a third year in a row, the longest losing streak since 1939-1941. Stock equity funds had their first negative year since 1988, with more than $10 billion coming out of the funds than going in to them, according to Denver-based mutual fund information provider Lipper.

This year started with a bang, as the Dow racked up more than 500 points. But that gain was wiped out as the talk of war intensified and the deadline neared for the report by U.N. weapons inspectors. The Dow has now lost 10 percent in the past two weeks.

Where Are The Jobs?

Job losses as a whole slowed in 2002. By the end of the year, there was a net loss of just 181,000 jobs. Pretty good, compared to the 1.4 million jobs lost in 2001.

But the jobs picture has weakened considerably over the past two months, with the number of monthly job cuts increasing (101,000 in December alone). More importantly, businesses are not hiring now and have not been hiring for the last 2 ½ years.

The unemployment rate stands at an eight-year high of 6 percent, as compared to 5.6 percent in January a year ago.

And businesses are giving no indication that they'll be hiring soon. Earnings were mediocre, at best, for the end of 2002. Many of America's big corporations have reduced their earnings expectations for 2003.

No earnings = no spending = no jobs.

Help From the Fed

The Federal Reserve tried to sweeten the pot in 2002 to entice businesses to start spending again.

In November, it slashed interest rates by a surprising half-percent to 1.25 percent and declared it was trying to help the economy through its "soft spot." The move made money cheaper to borrow, but few businesses have taken advantage of the incentive.

"The overriding problem remains the excess capacity brought on by the capital spending binge [of the 1990s]," says Chuck Hill, director of research at financial information provider First Call-Thomson Financial.

Others argue that the uncertainly surrounding a possible war with Iraq has kept a lid on spending. Many bellwether companies such as Microsoft and Intel have warned their spending won't increase significantly, at least in the first half of the year.

While most economists believe the Fed will leave rates unchanged when it finishes its latest meeting Wednesday, many agree with David Rosenberg, chief North American economist for Merrill Lynch. Rosenberg thinks the economy has weakened and the Fed has to acknowledge it. The Fed "has every reason to shift its risk assessment to one tilted towards weakness," Rosenberg wrote this week.

Now a growing number of economists are forecasting the Fed could cut rates by at least a quarter-percent when it meets again in March.

It Costs How Much to Fill Up?

Rising energy costs could also damage the already fragile economy, warn Bank of America Capital Management strategists Steve Young and Bob Benson.

"A prolonged period of high oil prices could weaken consumer and business spending, which would put the pace of U.S. economic expansion at risk," they wrote in a recent report.

Energy prices are higher than they were a year ago, pushed upward by talk of war with Iraq, the strike in Venezuela and a colder winter. The price of oil is hovering around $33 a barrel, as compared to $19.25 at the start of 2002.

That increase is being felt at home. The average price for a gallon of gasoline is now up to $1.47. That's 34 percent higher than a year ago when it was at $1.10. A gallon of heating oil now costs $1.45, up 25 percent from $1.16 last January.

Home Sweet Home

Economic news is not all doom and gloom. The consumer did spend on housing, and economists agree that this was the bright spot for the economy in 2002.

"Despite a year of uneven, below-trend economic growth, the housing market performed well in 2002," says Mickey Levy, chief economist for Banc of America Securities.

"The latest downward leg in mortgage rates reinvigorated sales in late summer and fall," he adds.

Interest rates hit new 30-year lows this past summer and are still hovering near that level these first weeks of January — 5.74 percent for a 30-year fixed-rate mortgage.

More than 5.56 million existing homes were sold in 2002, beating the previous year's record of 5.3 million homes sold. New homes sales hit their highest level since the government started tracking them 30 years ago.

Sellers, on average, got more than they originally paid for their homes. Prices were 7.1 percent higher than a year ago.

Americans by the millions also took advantage of low interest rates to refinance their homes. About 70 percent of all mortgages applied for last year were for refinancing.

The big question remains: Will demand remain strong?

David Resler, chief economist of Nomura Securities, sees some cracks. "These sales volumes suggest the housing market remains quite strong; the number of homes on the market fell in December," he says. "This could be an early sign of satiation after three straight record-setting years."