Reading the Economy's Faint Pulse

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No, the recession hasnít started yet.

Or rather, the recession didnít start 3-5 months ago. The Commerce Department reported Wednesday that GDP growth for the April-June second quarter was indeed positive, notching a 0.2 percent instead of the flat-zero number (or worse) forecasters were expecting. Yes, this is only the first revision of the Q2 number formerly known as 0.7 percent, and 0.2 percent is the weakest posted since the economy shrank at a 0.1-percent rate in the first quarter of 1993. But hey — itís not the size of the number, but the color of the arrow, right?

The morning see-sawing in the markets was understandable, because whether or not this is good news may depend on how long you think about it. The initial reaction to the before-the-bell report was positive but by mid-morning, losses had taken over, indicating that perhaps someone had actually read the report and failed to discover what the party was all about.

Once again, the folks keeping the economy above water were the consumers — and their new houses. Consumer spending, which accounts for two-thirds of U.S. economic activity, rose at an annual rate of 2.5 percent in the second quarter, stronger than the 2.1 percent rate originally estimated, and residential construction rose 5.8 percent.

But if youíre into tea leaves, those two very sectors were the ones hit by much worse — and much fresher — bad news this week. July existing home sales dropped 3 percent, realtors said Monday. And Tuesday the Conference Board reported that consumer confidence in August — the closest thing weíve gotten lately to a forward-looking economic indicator — fell to 114.3 from a revised 116.3 in July. Those two little items caused not-insignificant selloffs in both the Dow and NASDAQ on Monday and Tuesday. In which context a GDP-induced rally makes even less sense.

The report did bear one sign of hope going forward — inventory reduction, the necessary penance for any real recovery, was responsible for lopping 0.4 percentage points off the GDP figure, which can be viewed as a bitter pill well-swallowed. And another 0.3 percent came off because of falling exports, which arenít terribly relevant except as a gauge of the rest of the worldís demand. And thereís always the decline in the decline in profits — after-tax profits of U.S. corporations fell by only 2 percent in the second quarter, following a 7.8 percent decline in Q1.

But the sector that Greenspan and everybody else are all waiting for to turn this thing around — capital investment — is still bad and getting worse. Still shell-shocked by weak sales and those still-shrinking profits, businesses cut back in their investment in plants and equipment to the tune of 14.6 percent, the worst showing since the second quarter of 1980.

So what about the quarter weíre in now — and the one that starts in October? Well, the trend is still headed down. The six quarters preceding 2001 average out to 3.4 percent GDP growth; first-quarter growth stands at 1.3 percent. On any decent graph, the line connecting Q1 to Q2 to the near future doesnít lead anywhere good.

If itís only the color of the arrow that matters, we may yet stay in positive ground, if consumer spending gets its predicted support from the tax rebates and stays up over 2 percent growth, and if that corporate-profits trend line — the frantic layoffs and other cost-cutting must be helping — continues to head north to zero.

But staying out of statistically sub-zero territory and the technical start of a recession (defined as two straight quarters on negative growth) should be small comfort, whether itís in the quarter just past or the quarter weíre in now. The more constructive thing to look out for is the return of capital investment, and as long as thatís moribund — as along itís still sinking like a stone — quibbling about whether the economy is 0.2 percent above zero growth or below it is pretty much pointless, except in a White House PR kind of way.

Yes, the consumer is still the star of the show. The only thing that can turn this slowdown/correction into a bona fide, 1983-style, when-will-it-end recession is a collapse in consumer confidence and spending, and the good news is that hasnít happened yet. The bad news is that step one in the recovery — inventory reduction — isnít finished yet. And step two — capital investment — is still headed in the opposite direction. All of which means is that the work of the consumer in keeping us above the zero mark (and keeping us in denial about the bitter medicine weíre not nearly done swallowing) isnít nearly done. Not by a long shot.