Rarely have Wall Street’s seers been so split. Not only are they divided about where the economy is headed, they even disagree about how it is faring today. Pessimists, such as Nouriel Roubini of Roubini Global Economics, reckon output is slowing from its already desultory pace of 1.6% a year in the third quarter and that recession is imminent. Optimists say GDP growth is rising after a weak summer. After analysing bond, equity and credit markets, Stephen Jen of Morgan Stanley recently argued that the risk of recession was only 13%, down from 19% a month before.
How can opinion be so divided? The glib answer is that America has two economies: residential construction and car production are in a slump, but the rest is still chugging along. Such resilience is why the jobless rate fell to 4.4% in October, its lowest since 2001, and why both wages and hours worked grew smartly. But how sustainable that is depends on whether the sectoral declines worsen and spread.
Whether you look at housing or manufacturing it is hard to avoid some pessimism. Despite Alan Greenspan’s recent declaration that the worst of the housing bust is over, the evidence suggests otherwise. The pace of decline in residential construction may (perhaps) have peaked, but the size of inventories and the weakness of demand suggest builders will be cutting back for many months yet, and that prices have farther to fall.
Stephen Roach, also of Morgan Stanley and a well-known contrarian, points out that less than a third of the run-up in construction spending over the past decade has been reversed. As a share of GDP, residential investment is still far above its long-term average. And even if the worst is over for house builders, it may not be for the construction industry as a whole. Up to now, non-residential construction—the building of offices and shopping malls—has been booming. But September’s figures suggest that this, too, is losing steam. And the cuts are finally translating into fewer jobs. Overall, the construction sector shed 26,000 jobs in September. More lay-offs seem inevitable.
The news from manufacturers is also likely to get worse rather than better. Industrial production was flat in August and fell in September. Surveys of purchasing managers in October bode ill for the coming months. Carmakers are slashing production to reduce big inventories. The housing bust is hitting too. The production of housing-related goods—such as appliances and furniture—has fallen.
No matter, argue the optimists. The overall labour market is tight, wages are up and petrol prices have fallen. With wage income up almost 3% in real terms, spending will remain firm and the economy will rebound from its third-quarter lull.
This logic is sound, but there is little evidence, for now, to support it. Despite more pay and cheaper petrol, there are few signs that consumers splurged in October. According to Merrill Lynch, 62% of retailers missed their sales estimates. Wal-Mart had a particularly feeble month and expects sales to be flat in November. With their homes worth less, more Americans may be saving their wage gains rather than heading to the mall. The household saving rate, although still negative, rose from –0.8% in July to –0.2% in September.
Unless spending picks up as Christmas approaches, demand growth in the fourth quarter of 2006 is likely to be little better than in the third. It does not mean, however, that a full-blown recession is inevitable. Even if job losses in construction and manufacturing begin to push up the unemployment rate, the labour market will still be tight. With jobs plentiful and wages rising, consumer spending is unlikely to collapse. Slow growth and gradually higher saving is a less dramatic outcome than either the pessimists or optimists predict. But it has the advantage of being just what the economy needs.