Economic Forecast: The View from the Front
Looking to get a fix on where the '95 economy is headed? Well, you can listen to the pundits -- or you can figure it out the way smart company builders do
Calling economics an exact science is like calling Bill Clinton a soul mate of Newt Gingrich's. It's never going to happen. But that doesn't keep a lot of people from thinking they know precisely what the economy is going to do.
In an era when it's the economy, stupid, no one wants to look the part. These days we all have opinions on everything from M3 to G-7. Consider the recent experience of Bill Kelley, chairman of Consolidated Stores. Consolidated, based in Columbus, Ohio, is the country's largest retailer of closeout merchandise. Its stores do particularly well in areas where people on fixed incomes live, which hardly makes its aisles gathering grounds for Ph.D. economists. And yet "the other day I had a guy stop me in one of our stores and ask me where I thought the long bond was headed," Kelley recalls. But it hasn't always been that way. "Back in the late 1970s, when interest rates hit the front page, the average Joe didn't know the prime rate from a loaf of bread."
In a time when people claim to know more about the economy -- and are less sure about where it's taking us -- we at Inc. are happy to toss our share of rhetorical cordwood onto the fire. As we set out to find where the economy is headed this year, our idea was to talk to more than just the usual suspects -- those pundits whose pithy utterings on the macroeconomic view of things get lapped up daily by the mainstream media. We wanted to go deeper. We spoke, as well, to the doers, the growth-company managers who are out tangling with the economy daily. We wanted to find out not just what they foresaw for 1995 but what they were planning to do about it. Of course, for most company builders, planning doesn't mean changing strategy on January 1 or when the latest economic indicators come in the door. The process occurs on a continuum. It's a long-running movie, not a slide show.
Our sample is hardly scientific. Yet it's an effort to get at the increasingly schizophrenic nature of economic analysis. Economic data get mulled over and massaged more and more by the experts these days. But the view from the shop floor is invariably more nuanced -- and certainly as telling -- as deciphering the machinations of a $6-trillion economy through yet another string of data. So in the interest of equal time, we bring you opinions of what's going to happen in 1995 from not just the pundits but the planners as well.* * *
These days Cecil Ursprung is a committed globalist. He notes that U.S. gross domestic product stood at 40% of world GDP after World War II. By the century's end it could be 20%. He says he has never known a time when more of the world has been receptive to democratic capitalism. He sees the convergence of these major trends: a more favorable political environment, enhanced logistics and communication, and the withering away of trade barriers. Acting on his observations, Ursprung takes four or five trips a year outside the United States and subscribes to a number of foreign publications -- just to keep a global context in his head.
His company, Reflexite Corp., a $45-million maker of reflective signs, already gets nearly half its sales from overseas. The growth of overseas sales will accelerate this year as a stretch of focusing on domestic business ends. Says Ursprung: "In the United States we see signs that the current business cycle is maturing. We see very definite signs of inflationary cost pressures for the first time in four years, and we see some evidence of a slowing of the recovery that began in 1990."
Since then Ursprung has worked hard to improve operations. "We continue to look internally for better margins. The company shifted to work centers and self-directed teams. That produced productivity gains of 30% in each of the first two years. But it becomes harder to achieve such gains if you stay on the same curve."
Now it's time for Reflexite to change curves, to do less cost cutting in the United States and more boosting of volume overseas, where Ursprung sees business growing 30% this year, versus 20% in the United States. "We finally see signs of economic recovery in Europe. We believe the Far East is bottoming out." Pushing hard abroad, Reflexite has been doing joint ventures and setting up wholly owned companies in Europe and Asia. The latest venues include Japan, China, and Australia.* * *
Battening Down the Hatches
Smart planner that he is, John Birk collects enough data every week to choke a mainframe. And what he will do this year -- grow his company by 40% -- was inspired by what he discerned from that data in late 1993.
His $11-million company, Wright Express, based in South Portland, Maine, processes records of purchases of fuel, oil, and maintenance services made at more than 80,000 locations nationwide for vehicle fleets. All those data get fed into a finely tuned planning model, lending Birk an unusual edge: reliable leading indicators of the U.S. economy's strength.
Ninety to 120 days before the economy comes out of a recession, the number of monthly transactions and the average size of those transactions start to climb. In 1993 Birk's model told him that the economy was in danger of overheating. Consequently, he figured, the United States was due for some inflation and a rise in interest rates. That created a dilemma for Wright. His business was booming; he had to hire more people. But money would cost more and so would labor. He wanted to hold his prices down. Last year Birk projected he would have 144 employees by year's end. He ended up with 162, and this year he expects that figure to grow to more than 200.
To offset the higher costs, Birk launched a sweeping cost-control program. He took out a new bank loan at a low rate. He negotiated hard with suppliers, switching long-distance carriers to get discounts in return for a three-year contract. He also inked a 42-month contract for a state-of-the-art laser printer at virtually the same price as two older machines. The new printer has three times the capacity of his old machines. (That is important since the principal product that Wright "manufactures" is paper, in the form of invoices.) The 42-month contract is long enough to get Birk a good deal on the printer but not so long that he'll miss out on the next generation of machines.
Wright is also expanding into an adjacent building. Birk got the landlord to update the building so the energy bills would be lower. The company switched from electric heat to gas heat. "Overall, I'm not terribly concerned about inflation," says Birk. "Right now the economy's very strong," he says. His model tells him things are still rolling along out there. Back home, things are battened down.* * *
Dave Morse runs a monopoly, but that doesn't mean he's minting money. On the contrary. He's urgently trying to save it.
Morse is the publisher and chief executive of $6-million Courier Publications, based in Rockland, Maine, which publishes seven local newspapers along the state's central coast. Morse has one big nut to crack in 1995, and that is newsprint, which represents a third of his operating costs. Last year, after years of glut and favorable pricing, things started to change. You can almost hear Morse wince when he says, "The paper companies are aching for revenge. The pendulum is going to swing hard and fast. We know it." Newsprint prices went up 10% in December and are set to rise at least another 10% in June.
Morse thinks he can pass along half the cost increase to his advertisers before they start to resist. For the other half, he says, "we've looked at a variety of scenarios related to how we produce our papers." Morse will carefully build his newsprint inventory, consolidating weights of paper to hedge against spot shortages. Courier is cutting back on the frequency of special sections, and melding three papers into a single pressrun to save material and labor and produce greater uniformity among the papers.
Morse is hemmed in not just by paper producers but by a local, undiversified economy, and policies emanating from the planet of Washington, which he has no control over. "One of our big concerns is that consumer confidence will slump." That is a real possibility given Maine's "older demographic." The prospect of increased inflation and the uncertain state of health-care legislation could affect elderly people on fixed incomes, Morse worries. That would dampen consumer confidence and hurt the retail trade, upon which Morse relies for ad revenues. For him 1995 will be touch and go.* * *
You can be in the fat part of the economy and still be struggling. Just ask Charlie Duncheon, senior vice-president of sales and marketing at Adept Technology Inc., a San Jose, Calif., robotics manufacturer with more than $50 million in annual sales.
"We're riding the wave of factory automation. The good news globally is that the market for our product is strong," says Duncheon. "The bad news is that it is maturing." The current generation of robots is aging. Many customers are deferring purchases, waiting for the new line. "There's a higher level of value consciousness by customers. That means strong price pressures," says Duncheon. So instead of selling expensive, fully integrated robotic systems, Adept is concentrating more effort on selling simpler modular pieces of that system that customers can add on one at a time.
Duncheon sees North American business rising 20% in 1995, on top of a red-hot 30% gain last year. But in Japan and Europe business has been flat to down for the past few years. This year those markets will stir but not boom. That means that margins will remain thin, so Adept will focus on reducing its customers' installation time through a program dubbed Rapid Deployment Automation. Says Duncheon: "Before we spend a single dollar on developing a product, we ask ourselves, 'Does it allow the customer to rapidly deploy it?"
The company will also spend more effort with customers, helping them understand that good robot design results in ease of manufacturing for Adept -- and productivity gains for the customer. In the past customers would often order robots without being aware of technical problems Adept might encounter in manufacturing. Now, says Duncheon, Adept will ensure that customers understand "that ease of manufacturing for us is an integral part of product design."* * *
The Bill Comes Due
Ben Bailey is bearish on Bill Clinton, and that will affect how he runs his business this year. "There are no fundamental business problems with the economy, and that is a tragedy," he asserts. "We face a political problem. The administration has done several things that in the short and long term have affected capital investment in negative ways."
Bailey is chairman of ComputerBoards Inc., of Mansfield, Mass., a maker of data-acquisition and control boards for personal computers. ComputerBoards is a $10-million, 30-employee Subchapter S corporation and thus, claims Bailey, was swept up in the Clinton-tax-hike dragnet that targeted all the "rich" people in the economy. "Our taxes are up substantially as a result of the Clinton tax package. If you suddenly see 10% of your gross income pulled back, you can't grow. The spigot that fuels our growth has been turned back a notch. In this kind of a climate, business leaders will not aggressively invest in research and development and marketing," he says.
Last year, says Bailey, he spent $250,000 less on R&D than he had planned and hired 10 fewer people. "That's 25% fewer jobs as a direct effect of the tax package." In 1995, says Bailey, "we will spend a lot more time thinking about whether something is a sure thing before we spend money on it -- and we'll be more demanding about when it will pay off." That's hardly conducive to innovation. Currently, 15% of Bailey's sales are from overseas. He'd like to boost that to 40% in the next few years, but under the current circumstances he can't possibly afford the marketing investment.
An industry player since 1984, Bailey uses job quotes as a reliable leading indicator. His customers run the gamut of every kind of manufacturer as well as the major universities. When they're optimistic, Bailey fields plenty of quotes for new equipment. Right now "customers are just holding on." For many, making a big capital commitment to new technology in the current climate would be risky at best and fatal at worst. Bailey says the volume of quotes is off by slightly more than 80% since the peak in 1990. "We had good quotes through early 1993, but now it's a river that has run dry."* * *
Good CEOs -- unlike many economists -- always have an ear to the ground. That describes Russ Inserra, who these days spends less time worrying about the economy and more time honing his instincts about the right places to scare up business.
Inserra calls his strategy "looking for hot spots." Moving fast, staying mobile, and seeing the continent as his canvas is a big part of Inserra's plan for 1995. He says the economy is "a real mixed bag out there," adding, "we need to be more selective geographically about what we are going after." When Inserra, founder of Orion Construction, based in Houston -- which will have about $12 million in sales this year -- recently bid $1.2 million on a job in Salem, Mass., he knew he was in the wrong place. The low bidder was a local company that came in below Orion's cost.
Inserra thinks regional distortions in the economy will persist -- or even grow. Hawaii, pumped up by Japanese money, is overbuilt and depressed. Ditto for California. Boise and Albuquerque, powered by major corporate expansions, are on the rise. Says Inserra: "We have to take rifle shots. We have to look for corporate expansions and areas where local contractors are overloaded. That is where margins are moving up."
Any builder who can stay mobile and think national will survive in 1995, says Inserra. Sitting back and waiting for the local economy to improve is a recipe for trouble. He now also spends more time talking to engineers and reading their trade journals. They do the design work on jobs that are in the pipeline. He also keeps an eye on heavy-equipment auctions -- good leading indicators for Inserra -- which occur once a week. Rising equipment prices mean increasing construction activity in that market. Inserra is always prepared to travel to auctions where equipment is cheap and ship his purchases to a hot spot. He tries to make it to an auction at least once a month to pick up not just heavy iron but industry scuttlebutt from everyone from competitors to suppliers.
Inserra believes that "having a national mind-set is the only way you can survive." Local economies can "deteriorate" overnight these days -- and others can suddenly boom. Interest rates and inflation are secondary to that idea. "In a place like Boise, the local guys get so busy; there are not many other bidders. Once people get to capacity, prices start to move up." That's where Inserra wants to be -- for reasons other than margin. "Once we get into an area we usually end up with a second or third project, too."
Meet Dr. Gloom, alias Gary Shilling. "We'll go into recession starting sometime in the first half of this year," asserts Shilling, president of a Springfield, N.J., economic consulting firm that bears his name. Pricing power has returned to basic industries, signaling inflation. Consumers keep bingeing, despite high debt and layoffs. The recoveries overseas are "tentative" -- while interest rates "are rising universally." So those who see salvation in a 1995 export boom should scrap their hopes, warns Shilling. Besides, he adds, "the Asian economies are net exporters to the United States."
Shilling even tosses in a tart reminder of the 1930s. In 1936, he says, the Fed, fearing inflation, suddenly jacked up reserve requirements on banks. Interest rates shot up. Industrial production declined 38% in 1937 and 1938. Pundits dubbed it the "Roosevelt Recession," says Shilling, adding that Roosevelt also then raised taxes on the upper-income groups -- just as Clinton has done.
The way Shilling sees it, Clinton may fancy himself as FDR reincarnate -- but not this way.
Soft Landing, Shaky Pilot
Most times when the Fed sets out to cool off the economy, it brings on a hard crash. But the soft landing is always in vogue in some quarters. It's the last refuge of optimists such as David Wyss, research director at DRI/McGraw-Hill in Lexington, Mass.
"We are looking for a slowdown but not a recession. The 4% growth pace of the past year is unsustainable," says Wyss. "It should slow to the 2%-to-2.5% range." The soft landing of 1995, says Wyss, will look like those of 1966 and 1986, when the business cycle lengthened and the good times rolled on for three more years. Wyss sees the federal-funds rate rising to 5.25%. Inflation will tick up from about 2.7% to 3.0% in 1995, he predicts.
"People ought to be happier than they are; the economy is doing well," says Wyss. The trouble is, real hourly earnings are down 7% since 1973. Installment debt, which fell sharply from 19% of household income in 1990 to less than 16% by the end of 1992, is back at 17.5%. Purchasing power is up only because more people per household are working. Meanwhile, the cost of benefits is rising, keeping a lid on wage increases.
Soft landing? Hmm. The consumer, ever unpredictable, holds the joystick on the approach here.
David Bostian, chief economist at the New York City brokerage firm of Herzog, Heine, Geduld, complains that most economic models are simplistic and, therefore, inaccurate. Except his, which has 26 components versus just 11 for the government's index of leading economic indicators.
"Our model is incredibly accurate," says Bostian with incredible modesty. "It forecast the economy to be much stronger than the government's index showed during the first two years of the recovery." Now the reverse is true. The government's threadbare index masks economic weakness -- which Bostian's has sniffed out. "We still have tremendous debt hangover from the 1980s. The consumer has been borrowing to support the economy. That's doubly bad because interest rates are going up." Bostian says inventories have been growing "at a nerve-racking rate." Real gross-domestic-product numbers have "inventory accumulation" implying 4.1% annual growth built in, he claims, and yet "real final demand" -- what's actually bought and consumed -- is running at just 1.5%. "To liquidate the inventories would bring real GDP down to zero. We could be in for a painful slowdown," he warns.
Inflation as Decoy
The generals are always fighting the last war," says Walter Mead, a presidential fellow at the World Policy Institute at the New School, in New York City. Mead says that in the 1970s, inflation reignited because the government, fearing a replay of the Great Depression, pumped up the money supply. Now, Mead argues, policymakers are phobic about inflation when they should be worried about a contracting economy.
Mead says many economists focus on high rates of U.S. production capacity as signaling upward pressure on prices. "You now have to look at global capacity, and a lot is coming on-line," he counters. "If you look at prices in yen and deutsche marks, we are actually in a deflationary period. Consumer prices in Japan are dropping. You can get a spike in the price of gold, and people assume that's an inflationary signal, but that could be China alone responding to inflationary pressure in its economy."
Mead adds, "I don't see any sign of a boom that could get out of control." He worries, rather, that any fresh shoot of growth could get trampled in Mr. Greenspan's neighborhood.
Maureen Allyn says the oft-mentioned threat of a capital shortage -- which sends interest rates sky-high around the globe -- is overblown. "The excess savings are bottled up in Japan," she says, noting that since 1985 Japan has accumulated an $850-billion current-account surplus. "The last couple of years have seen very little capital outflow. This is a capital blockage, not a shortage." She says the Japanese were burned by many "trophy" investments they made in the 1980s. The money will soon cycle back, but this time into more productive investments. That will help sustain growth in 1995 at 3.5%, says Allyn, chief economist at Scudder, Stevens, & Clark, in New York City.
But selectivity is the key. Allyn sees a "pricing rotation" away from finished consumer products and services and toward raw-material suppliers and value-added producers of capital goods -- machine tools, construction equipment, and the like. "What will sustain growth is capital spending and exports," says Allyn, who notes that corporate profit margins are at a 15-year high. "Exports are where orders are taking off." n