Economy slowed, not stalled

The US economy is entering spring with less wind at its back than it has had for the past four years.

Although the slowdown is still not a big concern of most economists, they warn that an economy that is moving more like a tortoise than a hare is at greater risk of being overrun by some outside event – perhaps one that causes a recession or a period of very slow growth.

But a sustainable slow-growth economy does have a bright side: Inflationary pressure is likely to ease, keeping the Federal Reserve from raising interest rates for borrowers.

One sign of economic slowdown came Wednesday when the government revised downward – from 3.5 percent to 2.2 percent – its estimate for the fourth-quarter gross domestic product (GDP). The new number marks the largest revision in quarterly GDP in at least 15 years. That news followed a tumultuous Tuesday, when the Dow Jones Industrial Average plunged 416.02 points, one of its most volatile moves in years. As of midday Wednesday, the market seemed to have stabilized.

Most economic forecasters say the market's acrobatic moves aren't the kind of exogenous event that would trigger a downturn in the economy. Wednesday, Federal Reserve Chairman Ben Bernanke, appearing before Congress, said there is "no material change" in the outlook from the last time he testified two weeks ago. The downward revision in the GDP, he added, was consistent with the central bank's outlook for "moderate growth." If the economy can work through its current problems, especially in the housing market, it could strengthen later this year, said Mr. Bernanke.

Wednesday, however, the housing sector received another shot of bad news. Sales of new homes fell 16.6 percent in January over the same time last year, the steepest percentage drop in more than a decade, the US Commerce Department reported. The number of unsold new homes continued to rise, and the median price fell 2.1 percent as developers dropped prices to attract buyers.

Housing is not the only sector that's bogged down. Orders of durable goods fell 7.8 percent in January after rising 3.6 percent in December, the Commerce Department reported Tuesday. Durable goods are big-ticket items such as airplanes and construction equipment.

"It's a mystery, in a way. The fundamentals should be positive for capital expenditures. It should be booming," says Dan Meckstroth, chief economist for Manufacturers Alliance/MAPI in Arlington. Va. "Corporate profits are at an all-time high. Companies have so much cash they are buying back their shares because they say they can't find a better use of their money in their own business, and factories are running at a relatively high rate."

The negative economic reports come on the heels of some recession warnings. Former Fed Chairman Alan Greenspan, speaking Monday in Hong Kong, noted that corporate profit margins were starting to shrink – a possible sign of the end of a business cycle. As the business cycle ends, he cautioned, the US economy could be moving closer to a recession, perhaps by year's end.

A recession by year's end or early in 2008 is a scenario that makes sense to Hugh Moore of Guerite Advisors in Greenville, S.C. He has been bearish on the economy and the stock market for some time, saying the determining factor will be the "popping asset bubble" in the real estate market. "It will take away a lot of the impetus for consumer spending," says Mr. Moore.

Other Wall Street advisers, however, are more sanguine. Jeff Kleintop, chief investment strategist at PNC Wealth Management in Philadelphia, notes that Mr. Greenspan had also predicted a downturn in 1995. "We had another five years of economic expansion," says Mr. Kleintop.

Kleintop, who has been bullish on the markets and the economy, sees several years of life left to the current business cycle. "We are at the midpoint of the expansion," he asserts. "We are just having a soft spot."

Despite the downturn in housing and durable goods, some other sectors – such as information technology, telecommunications, and nonresidential construction – continue to perform well, says Richard DeKaser, chief economist at National City Corp. in Cleveland.

"Whenever you get this kind of moderate growth, you end up with a mixed bag, with some sectors performing well and others poorly," he says.

One thing on which many economists agree is that Tuesday's stock-market slide came at a time of investor complacency. That complacency was shaken when the Chinese stock markets plunged 9 percent amid rumors that Chinese authorities were planning to crack down on speculation in their markets. Some commentators termed it "the Shanghai surprise." Wednesday, the Chinese markets recouped about half their losses.

However, the selling in China spread quickly on Tuesday to the European markets and then to the United States. The Standard & Poor's 500 index fell 3.47 percent. In an indication of how stable the markets have been recently, it was the first time since May 2003 that the index had fallen by more than 2 percent in one day.

"We can expect in the next week or two [that] the markets will be jittery or unstable, as investors come to terms with what happened," says Bob Brusca of Fact and Opinion Economics in New York. But, he adds, "the Shanghai market is not a bellwether for the rest of the world."

Market volatility can be a good thing, says Axel Merk of Merk Investments in Palo Alto, Calif. "People are just too confident," he says. "With greater volatility they will have to pare down their bets."