How We Missed Signs Of A Slowdown

It was all going so well.

Joblessness was at its lowest level in 30 years. Prices were in check. Productivity had surged to levels not seen since the 1960s. Early last year the economy was on a luxury cruise ordering umbrella drinks. Conditions seemed so perfect that a new, more cocky breed of economist was arguing that the New Economy had changed history. Recession? A relic. Despite falling stock prices, this optimism continued into autumn, with one prestigious group of business economists predicting "solid growth ahead with no end to the expansion."

And then it happened. After the economy roared at a 6% rate of growth for the 12 months ending last June, economic pundits looked on in horror as it all began to cave in right before their eyes, with the economy edging close to zero growth. Imagine being in a speedboat going 60 m.p.h. and suddenly hitting a sandbar. It was a rude awakening. New Economy or not, the business cycle turns out to be alive and well. And hungry.

"We entered a hard landing sometime last summer," says Allen Sinai, chief global economist for Decision Economics. "And we are in at least a hard landing now. The odds are pretty high that we could end up in a full-fledged recession." Sinai sounded the alarm early last year, but most forecasters were blindsided by the speed with which the economy deteriorated. And they took us down with them.

Why did they blow it so badly? How did they run through the STOP signs? And could we have gleaned something they didn't in the months leading up to the slowdown? Here are some of the turning points that ultimately led business activity on a downward spiral.

Long in the Tooth
This expansion was overripe for a downturn. For a half-century the natural business cycle followed roughly the same pattern: three to four years of solid growth followed by a one-year recession. Amazingly, the current economy had been chugging along for 10 years with little evidence of tiring. In March 2000 the expansion officially earned the distinction as the longest in U.S. history. That in itself should have kept us on alert.

But the ebullience that followed distracted many experts from recognizing that the seeds of the downturn had been planted.

"If there's a surprise, it's really that we're going to see the economy slow in the middle of the year, but then I think we're going to see a big reacceleration in the second half [of 2000], and we're going to end the year very strongly, just as we ended 1999." --Gail Fosler, chief economist, The Conference Board (on cnnfn's Moneyline, Jan. 3, 2000)

Wall Street's Warning
The stock market has always been a terrific leading indicator of the health of the economy. Though some experts like to poke fun at how Wall Street has successfully predicted eight of the past five recessions, anyone who ignored the market's warning last spring didn't chuckle for long. What followed offered the most telling demonstration of the market's predictive value.

The S&P; 500 reached its all-time high of 1527 on March 24, 2000. After that achievement, stock prices didn't just slip; they imploded. Market historians note that every recession in the past 50 years has been preceded by the S&P; 500's dropping an average of 7.7%. If economists and investors had remembered that pattern, they would have fastened their seat belts. As it turned out, the stock index plummeted exactly that amount barely three weeks after its March peak.

As equity prices cascaded, so did consumer enthusiasm. The Conference Board's index of consumer confidence reached its high in May at 144.7 and then deflated. By year's end Americans had lost nearly $3 trillion in stock-market wealth. Spending took it on the chin. Outlays by individuals are now about half the pace of the previous two years.

"It is wrong to worry that strength of consumer spending is contingent on a strong stock market." --PaineWebber investment strategist Edward Kerschner (Dow Jones News Service, May 9, 2000)

Yes, Tech Wrecked It
This expansion, unlike previous ones, had been driven mainly by the tech and Internet sectors: software, computers, networking and semiconductors. How much of the downturn in U.S. economic growth can be blamed on the burst of the dotcom bubble? A lot!

Information technology was the fastest-growing sector of the economy over the past three years. Corporate spending on computers, networks and software took off in recent years, rising 23% in 1998 and an additional 26% in 1999. Little wonder that tech stocks soared while the rest of the market was basically flat. For example, in 1999, when the Dow Jones industrial average rose 25%, the tech-heavy NASDAQ soared 85%.

An example of how the bubble began to leak came in March when the financial weekly Barron's warned that Priceline.com , a high-profile Internet company, would be buffeted by serious competition. That same month, Priceline's on-air spokesman, former Star Trek actor William Shatner, sold a large chunk of his Priceline shares, netting a quick $3 million. A barrage of other company insiders did the same. Get out, they were saying.