Is The Economy Slowing?

10/23/00 02:30:42 PM PST

by Jayanthi Gopalakrishnan

Is The Economy Slowing?

In spite of the Y2K panic, the year 2000 started out on a positive note -- until April, anyway. What was there to complain about? Things looked rosy. The Dow Jones Industrial Average (Djia), the Standard & Poor's 500, and the Nasdaq Composite had reached their all-time highs in April 2000, and there was no reason to believe those highs would not be surpassed; 1999 fourth-quarter Gross Domestic Product (Gdp) increased by more than 8%; consumer confidence was up, unemployment was low -- what was there to complain about? Things looked rosy. Until that April, anyway.

Now we're close to the end of that same year, and things look very different. In fact, there are signs that ever-darkening clouds may be hanging over the economic horizon. For one, the stock market seems hesitant to reach for its April highs again. For another, Intel Corp.'s announcement the company would not meet its third-quarter earnings estimates frightened many investors away from much of the technology sector. Intel blamed its earnings shortfall on lower sales in Europe; not surprisingly, the weakness in the euro plays an important role in economic performance. Add rising oil prices to that, and those darkening clouds are downright threatening.

Two events occurred in September that added texture to the economic landscape. First, to answer the cry for cheaper gasoline and provide the market with some temporary relief from high gas prices, President Bill Clinton decided to release oil from the US Strategic Petroleum Reserve. Second, the US government joined forces with Japan and European nations to help boost the euro. At that time, the euro had reached a record low and crude oil prices had reached a high of $37 per barrel. Rising oil prices and the ailing euro are both major concerns, since they have an adverse effect on corporate earnings, which in turn affect price activity in the stock markets.

With that in mind, as well as the recent spate of interest rate increases, did Federal Reserve chairman Alan Greenspan tighten interest rates too much?

Figure 1: Gross Domestic Product (GDP). Since the 1970s, the Gross Domestic Product has been increasing steadily.

Figure 2: Components of the US economy. The US economy is made up of several components, such as retail sales, unemployment, housing starts, and productivity.

Our lives at present
The Gdp has been growing consistently since 1975, with the last quarter of 1999 experiencing 8% growth. A glance at Figure 1 gives you the picture. With an economy growing at this rate, the biggest fear is inflation. As a result, it is in the Fed's interest to curb inflation and sustain economic growth. Instead of having an economy growing at a rate of 8%, the Fed is interested in seeing an economy growing at a more modest one -- say, 3-5%.

There is a strong correlation between the Fed's action on interest rates and Wall Street's reaction to the Fed. Since summer 1999, the Fed has raised rates six times, with the largest increase in May 2000, when it raised rates by 50 basis points, or half a percent. Since then, the Fed has held interest rates stable and is expected to do so for the remainder of the year.

Generally, when the Fed makes a change in interest rates, the effects will be felt after a period of about two months. Economic numbers for second- and third-quarter 2000 seem to be in line with the Fed's objectives for slowing down growth. Inflation is tame and housing starts and retail sales have declined, while unemployment has increased. The Labor Department reported that the Consumer Price Index (Cpi) fell 0.1% in August after gaining 0.2% in July. Industrial production and inventory investment are slowing. At present, the major concern is rising oil prices. Even though high oil prices are traditionally associated with inflation, most analysts feel that rising oil prices will tighten consumer budgets and reduce demand for other goods and services, decreasing inflationary pressures and thus slowing economic growth.

Soft or hard landing?
Believe it or not, this slowdown, together with the rise in oil prices and decline in the euro, in no way suggests that the US economy will be confronted by a recession. The economy is still growing, and most analysts believe the economy has taken a soft landing. In fact, if you were to analyze underlying basics such as investment in technology and innovation, there are no signs of negative growth. In fact, global growth has shown signs it is picking up.

The US economy is expected to grow between 3% and 4% in 2001. That's markedly slower than the 8% growth in fourth-quarter 1999, but that doesn't mean corporations will experience less than double-digit growth or technology stocks will give you only modest returns. It simply means you must keep abreast of economic indicators (Figure 2) such as inflation, consumer confidence, and employment to anticipate how the stock markets will react. This way, you will be able to allocate your funds appropriately.

In all? Keep your eye on the financial news. Knowing what's going on will help you, either in the short run or the long one, to grow your portfolio.

Jayanthi Gopalakrishnan

Staff Writer

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