The Insider's Guide to Economic Forecasting
A well-known economist pulls back the curtain on the indicators he and other top insiders use to figure out where the economy is headed. These indicators can guide you, too.
In recent months, most conversations about the direction of the economy locked on to a single crucial indicator: our national security.
Would swift victory in Iraq be a cure-all for our economic ills? Or would continued global anxiety produce a poor climate for business? Now that the elephant has left the room, what should have been clear all along is even more apparent: The U.S. economy -- for better or worse -- is shaped by a diverse mix of factors. To understand what is happening necessitates deeper inquiry.
Recently, the projections of many top forecasters have taken an optimistic turn. The stock market also has been more robust. But the picture is hardly clear. Stocks are a notoriously unreliable indicator -- as the "sucker's rallies" in both 1974 and 2002 showed.
As every entrepreneur learns at some point, correctly reading trends in the economy can make or break a business. Just ask a retailer who guesses wrong about how much merchandise to order for the coming season, a factory owner who fails to expand in time to meet a surge in demand, or a developer who decides to put up office space just before a recession. Of course, company owners already have a good sense of how the economy is doing just by looking at their own business. To help Inc. readers round out their knowledge and forecasting abilities, I have assembled a guide of lesser-known but important economic signposts used by some of the nation's savviest insiders, including some I used myself while serving as President Clinton's top economic adviser. These are not the usual stats you read about in the newspaper.
For instance, if, like many others, you think unemployment statistics aren't telling the whole story in the labor market, you might instead want to keep an eye on the fate of the temp industry. Or if you believe consumer-spending stats tend to be inflated, you could follow year-to-year sales receipts at Wal-Mart stores.
You don't have to have a doctorate in economics to find this information. In fact, not only does this guide tell you precisely where to get it, you can even go to a new tool at Inc.com that offers a direct link to most all of the hard-to-find sources mentioned below.
Ever since a falloff in business spending preceded the recession in 2001, forecasters have been trying to project when businesses will start investing more money in plant and equipment. Many economists closely track industrial capacity figures in an attempt to guess when companies will need to build more factories, but Federal Reserve Chairman Alan Greenspan just picks up the phone. Though Greenspan is renowned for finding significance in economic minutiae, it's also no secret that he often speaks with the chief executive officers of major companies to get a sense of how badly they are lusting after the latest in machine tools.
The periodic surveys of two of the most prominent organizations of business CEOs -- the Business Roundtable and the Business Council -- do a good job of summarizing CEO mood swings for those of us who can't get Warren Buffett or Edsel Ford on the phone. Both groups ask CEOs their expectations, not only for the general economy, but also for their specific businesses.
Recently, both surveys have shown themselves prescient. For instance, last September many economists were going public with predictions that an economic uptick might be imminent. A report from the Business Council suggested otherwise. Of the CEOs it had surveyed, 78% had said that they planned to either reduce their company's capital spending or keep it the same. It's easy to see how the CEO survey did a much better job of forecasting than the optimistic economists.
The most recent CEO polls continue to foretell sluggishness. In April, the Business Roundtable reported that 82% of CEOs in its poll did not anticipate increases in capital spending. What's more, fewer than 10% of the CEOs in the Business Roundtable poll expected to hire new employees, while nearly 45% expected work force reductions.
Another CEO survey, conducted this April by Goldman Sachs, found a strong preference among CEOs for investments in existing assets in coming months and recorded an overall gloomy outlook on business prospects. For the time being at least, the aggressive CEO of the late 1990s has been replaced by a more cautious leader who may need to see more significant signs of a recovery before committing company resources in a major way.
The next Business Roundtable survey is scheduled to be released in July; expect improved spending and hiring projections for the second half of 2003. The next Business Council survey is due out the second week of October.
Economists often study changes in payroll employment as a lagging indicator. Businesses emerging from a downturn tend to avoid incurring the new fixed costs of hiring full-time employees until they have confidence that recovery is real and robust. Harvard economics professor Lawrence Katz, one of the nation's foremost labor economists and former chief economist at the Department of Labor, always advised me when I was at the White House to keep an eye on the temporary labor market. He based his case on its track record as a leading indicator in the past two recessions.
As one might expect, this indicator has been dismal for quite a while, offering little comfort that employers will be adding to their payrolls any time soon. Between July 2002 and April 2003, a total of 100,000 temp jobs were cut. If this drop-off had been occurring while total employment was increasing, we'd all have had reason to celebrate (a sign that companies were replacing temp workers with permanent ones), but during the same period, total payroll employment fell by 299,000 jobs.
The first glimmer of hope came in May as temp employment rebounded by 58,000 jobs -- the largest one-month increase since October 1999. A central question is whether the impressive one-month showing on temp jobs in May is an aberration, or whether it is a signal that the labor market has already hit the bottom and is now headed in the right direction.
Another indicator to watch in the labor market is the number of people who'd rather be working full-time but have had to settle for a part-time job. One might think these folks would be considered half-unemployed in calculating the overall unemployment number, but they are not. In addition to the 9 million workers classified as unemployed in May, there were another 4.6 million workers who were classified as "part-time for economic reasons." That represented a 39% increase from the level recorded in March 2001.
Data: Bureau of Labor Statistics data on part-time workers for economic reasons is at http://www.bls.gov/cps/home.htm. Scroll down to "Historical data for series in the monthly Employment Situation news release" and look for table A-5. The BLS compiles data on temporary jobs, under the label "Temporary Help Services" at www.bls.gov/ces/home.htm. Data from the most recent month is included on the "Employment Situation Summary." For a historical series, click on "Get Detailed Statistics" and choose the "Historical Data for the 'B' Tables," then click on "Employees on nonfarm payrolls by industry sector" and scroll down to find "Temporary Help Services."
The workhorse of the precarious recovery over the past year and a half has undoubtedly been the American consumer. Despite a continual stream of gloomy economic news, shoppers have kept right on shopping and, in so doing, have kept the economy out of more serious trouble. Economists have been watching whether consumers will continue propping up GNP until businesses decide that they also want to buy more stuff. A good set of binoculars through which to view the health of consumer spending is retail sales at major chain stores like Wal-Mart and Sears. There are a number of ways to get information about their stores' performance.
Same-store sales are the key number for these big chains. The figure measures sales growth at stores that have been open for at least a year. By excluding sales made by newer stores, it keeps a company's expansion efforts from distorting the broader economic picture.
It was Mark Zandi, the chief economist at the influential consulting firm Economy.com, who told me I ought to keep especially close tabs on the same-store sales at Wal-Mart, which the company makes available at its website. Zandi told me that looking at same-store sales is "like having a box-seat view on what consumers are doing." As the world's biggest corporation, responsible for an astounding 2.3% of U.S. GNP in 2002, there's truth to the idea that where Wal-Mart goes, so goes the economy. Wal-Mart sales have become increasingly important in recent months as they continue to perform well compared with other retailers. Indeed, Wal-Mart has been a large factor in holding total retail sales above water. Average year-to-year same-store sales in 2003 excluding Wal-Mart have been only 0.7%. Any further weakening in Wal-Mart's sales could be an important sign that the American shopper is beginning to have trouble as the solo pillar of the economy. Most recently, Wal-Mart reported sales for May 2003 of $18.95 billion, an increase of 10% from $17.23 billion in the prior year.
You can also find data for same-store sales across 76 major chain retailers by looking at the Bank of Tokyo-Mitsubishi Retail Chain Store Index. The index seemed to be making a recovery in the beginning of 2002, with sales for each of the first six months averaging year-to-year increases of close to 5%. But sales have dropped off since June 2002, fueling fears that consumer demand may be mild. So far in 2003, average year-to-year sales growth has been a lethargic 1.5%.
Data: The Bank of Tokyo-Mitsubishi Retail Chain Store Index is released monthly at www.btmny.com/reports/research/comment/Chain_Store_Sales.htm. Click on the most recent month's retail trends report. You can follow weekly same-store sales for Wal-Mart at its corporate website, www.walmartstores.com. Look for "Sales and Summaries" under the News Releases section.
You might want to follow year-to-year sales receipts at Wal-Mart stores.
A good way to gauge business investment trends is to check bank lending. Commercial and industrial loans (CIL) is a particularly important indicator because such loans are often used by small and medium-size businesses to finance inventory and materials. I happen to know that CIL is another favorite statistic of Alan Greenspan. CIL acts as a "you know you're out of the woods when..." indicator. Indeed, the Conference Board, a not-for-profit group that conducts market research, uses CIL as a key component of its "lagging economic indicators" index (the cousin of its better-known index of leading economic indicators). Viewed correctly, though, CIL can also be a leading indicator. In the past two recessions, the volume of commercial and industrial loans continued to fall even as growth revived. For example, CIL bottomed out in December 1993, two-and-a-half years after the end of the 1991 recession. In the current slowdown, CIL is continuing a two-year decline: In April, CIL was down to $943.5 billion -- its lowest level since October 1998 -- from a high of $1.1 trillion in February 2001.
The slow recovery in CIL reflects weak demand for credit from businesses that are hesitant to make new investments, especially if they are already carrying a lot of debt. It also reflects tighter standards by banks in response to the increase in bad loans following the excessive lending of the boom years. The Federal Reserve's quarterly survey of senior loan officers at major U.S. banks also sheds light on banks' willingness to extend new credit.
A good way to gauge business investment trends is to check commercial and industrial loans.
This survey is doubly relevant for Inc. readers because it asks loan officers about the movement of standards for small and medium-size businesses as well as for large corporations. In the first quarter of 2003 the survey provided good overall news for the supply side of new lending, with only 10.7% of banks reporting tightening of lending standards, compared with 22% in the previous quarter. But for small companies, the share of banks tightening standards actually increased slightly, from 13.8% in the fourth quarter of 2002 to 14.5% in the first quarter of 2003. Look for any flattening in the decline of CIL in coming months as a sign of life in the demand for credit, and look at the quarterly Fed survey (out in July) to see if banks are loosening up, especially for small firms. While CIL may not actually begin to pick up until late 2003 or into 2004, in the interim you should look for a leveling off of the decline. That may be a good sign that a recovery is afoot. By the time CIL actually picks up, a recovery is almost certainly well on its way.
Data: CIL is released by the Federal Reserve weekly for "large commercial banks" and monthly for "all commercial banks." You can follow the latest press releases here: www.federalreserve.gov/releases/h8, and get historical data and analysis via the St. Louis Fed at: research.stlouisfed.org. The Federal Reserve's Quarterly Bank Officer Survey is available at www.federalreserve.gov/boarddocs/SnLoanSurvey.
Most every business is somehow tied to the technology sector. Because of this, you can tell a lot about both the health and direction of the ailing sector by keeping an eye on the semiconductor industry, as chips are used in just about everything produced these days.
One of the best gauges of movement in the chip market is what is known as the "book-to-bill" ratio, which compares new orders "booked" to actual shipments being "billed." Steve Cullen, director of semiconductor research services at In-Stat/MDR, a market research firm, explains that the book-to-bill ratio is "great for the nonprofessional economy watcher because it gives a quick, reliable indication of whether things are getting better or worse."
The ratio was a good predictor of investment in technology during the last recession. When the ratio is one, things are at steady state. For every $1 million in past orders the company bills for, it's booking another $1 million in new orders. When bookings exceed billings (a ratio over one) it signals that demand is picking up. During the 1990s, the book-to-bill ratio for chips was such a strong predictive indicator that it began driving stock prices of companies releasing the information. As a result, most decided to pull the plug on disclosure.
What companies still do make public are bookings and billings for "semiconductor equipment" -- i.e., the materials that go into making chips. The book-to-bill ratio began falling from a high of 1.46 in March 2000, about six months before investment in computers and software hit its peak. It bottomed out at a dismal 0.44 in April 2001 and, after making a brief rebound in the first half of 2002, has been below one for the past nine months. In May, the book-to-bill stood at 0.89, with new bookings at $751 million, down 32% from those posted a year earlier. Pay attention in coming months to whether the book-to-bill continues to slide or breaks above one.
Data: The book-to-bill ratio is measured by the Semiconductor Equipment and Materials International; get the monthly press releases at www.semi.org/web/wpress.nsf/url/booktobill.
Investment in computers has been growing strong for more than a year, yet business investment in structures -- such as office buildings, factories, hospitals, and other institutional buildings (the category also includes utilities and mines) -- has yet to recover. Insiders such as Richard Berner, Morgan Stanley's chief U.S. economist, have referred to the end of this construction bust as an important "milestone for recovery."
Investment in structures did grow during the first quarter of this year, but for only the second time since early 2001 (the other time being a temporary blip in the third quarter of 2001). However, the growth rate was a meager 0.4% a year and investment is still down 25% since the last quarter of 2000. Few businesses are currently looking to expand -- and therefore have no need to build offices. A strong rebound in investment in structures may be a while coming. Even once businesses start thinking of hiring new employees, they won't need to invest in new construction if there is still office or factory space left over from the last boom. That was the experience after the last recession. Employment growth had already picked up by 1994, but it was another few years before investment in structures began to grow rapidly.
The last recession suggests, however, that when investment in office structures stops falling, employment will soon rise. It is a sign that businesses have put pessimism behind them. The latest data may be hopeful if the scanty growth of the first quarter of this year establishes that structure investment has bottomed out.
Data: Investment in nonresidential structures is available as part of the Bureau of Labor Statistics' NIPA series -- the same series that includes GDP. Go to the Bureau of Economic Analysis website at www.bea.doc.gov. Click on "GDP and related data" and then on "Select data from the full set of NIPA tables." Follow the link to the list of all NIPA tables. Look for Table 5.5, "Real Private Fixed Investment by Type," under the "Savings and Investment section."
In 2001, many predicted that, with more than half of Americans invested in the stock market in one way or another, the fall of share prices would make consumers feel less wealthy, and thus encourage a new wave of frugality -- meaning an even deeper economic downturn. But the American consumer defied all expectations, not only increasing spending by a respectable 2.5% -- but actually buying big-ticket items such as automobiles and homes.
Top economists at the Federal Reserve and elsewhere are starting to appreciate that for most middle-income families the most powerful thing impacting the so called "wealth effect" -- the degree to which one's perceptions of personal wealth affects spending and consumer resilience -- may be the value of one's home. Influential economists Robert Shiller, author of Irrational Exuberance, and Karl Case and John Quigley found in a recent study that "the housing market appears to be more important than the stock market in influencing consumption." Beyond the psychological impact of the wealth effect, many homeowners have actually been borrowing against the increased value of their houses, further fueling consumer spending.
Some think we may now have a potentially dangerous housing bubble that could pop. Pessimists point to ominous statistics. In September, Morgan Stanley's Stephen Roach wrote that since 1997, housing prices had been growing three times as fast as rents, often a sign of an asset bubble. Kenneth Rogoff, director of research at the IMF, has found that housing prices are up nearly 30% since the mid-1990s (after adjusting for inflation), the strongest surge since 1970.
A host of other experts, however, including Chairman Greenspan, believe that housing prices are simply a reflection of underlying fundamentals: low interest rates, income growth, and rising demand for housing spurred partially by demographics and immigration trends. Whether or not these are signs that a bursting bubble awaits us, many analysts fear that a flattening of values or a sharp uptick in borrowing costs could drain the economy of housing's impressive support of consumer spending.
That's why the next few months of housing sales and price data will be important to monitor, as any flattening or declines in the housing market could be bad news for a still-fragile recovery. And even if sales as well as prices stay steady, don't expect the bump from housing that we have benefited from in the last two recoveries.
Data: The OFHEO's quarterly House Price Index is available at www.ofheo.gov/HPI.asp. New homes sales are reported by the Census Bureau at http://www.census.gov/const/www/newressalesindex.html.
Gene Sperling is a senior fellow for economic policy at the Council on Foreign Relations. He was director of the National Economic Council from 1997 to 2001, serving as President Clinton's top economic adviser.