The Interrupted Recovery, Redux
by Robert W. Bradford

As we stated in our last issue, 2003 started out looking like a fine year of recovery from the 2001-2002 recession. The war in Iraq pulled us back from the brink of real recovery. While this did not technically put us into a recession, the economy's performance for the first quarter would best be described as "lackluster". That being said, we will point out a few key economic indicators that point to a much better finish to 2003 and (barring unforeseen events) a significantly improved 2004, as well.

In our last commentary, we predicted negative consequences for the US economy stemming from the war in Iraq. Our main uncertainty regarding this was the extent and duration of the damage to the US economy caused by the war, and the best data we could use for this prediction came from the experience we had with Desert Storm. We pointed out that many of the negative effects were somewhat reduced this time around, with the exception of depressed spending due to fear and uncertainty, which could be greater. To a great extent, this prediction proved to be correct, but we failed to point out the positive benefit of the morale boost from the end of the war. While this was not huge, we see early signs that it will have a perceptible effect on the US economy as consumers and businesses relax, heave a sigh of relief, and begin to loosen their purse strings.

Looking at the 1st quarter 2003 numbers, we see that growth in consumer spending and GDP slowed a bit from Q4 2002, which is to be expected. The best news in the first quarter data is probably the big jump in orders for plant and equipment, which grew a tremendous 7.5% for the quarter. This increase is clear evidence that US business decision makers were starting to ease up their grip on the investment purse strings despite the threat of a coming war. This, combined with stable inventories, made us think the recovery had really started before the Iraqi war began. We suspect that the next couple of months will show us some unpleasant downturns in those numbers — remember, they are always one to three months old — but that we will see strong indications of a modest but noticeable bounce-back in the Fall.

As stated in our last issue, low interest rates have created a boom for construction and bank refinancing — but will not likely continue indefinitely. Again, if your industry is driven by construction, you should prepare for a very tough reaction to increased rates, when and if they come along. Construction-related industries are already showing signs of suffering from pre-war nervousness, and it's not clear that there is any further stimulus from rate cuts in the future.

The first quarter employment numbers also give hope that the economy is preparing to enter a new growth period. With employment up, unemployment down and manufacturing hours increasing the economy seemed to be warming up in the first quarter. One key damper on this picture is the stable capacity utilization number, as overcapacity still plagues many markets around the globe. Capacity utilization numbers will have to increase significantly before people in many industries start to feel that the good times are back.

As we predicted in the last issue, the Crude Materials Price Index continued to rise in the first quarter as war jitters led to price speculation, especially in oil. A strong quarterly increase in producer prices has followed last quarter's Crude Materials increase and will likely extend into next quarter. Right now, many players on the end of this chain — retailers and consumer products manufacturers — are wrestling with the issue of whether (and how) to pass along these increasing costs to the consumers. This will be a particularly vexing problem for anyone who has become addicted to the mass discount retailers as a channel, since the Wal-Marts of the retail world aren't at all receptive to price increases.

As we said last issue, a little inflation can be good for stimulating economic activity — but we need to be wary of inflation and higher interest rates that may come up as the Fed seeks to stave off that inflation. Higher interest rates in particular will be a worry when the Fed decides that the economy is growing quickly enough. Notice that we are already seeing Housing Starts being hit as consumers decide their appetite for finance-driven home acquisition is satiated. Whether housing will have picked up in the third quarter (as nervousness about the war subsided) remains to be seen.

The declining Composite Leading Indicators indicate a resumed possibility of recession in the coming year, but this is most likely driven by the growing impact of the war on the economy in the first quarter. Our take on the impact of the war — which won't really be known for months — is that it likely depressed numbers in the first and second quarter and will have a mildly depressing effect on the third quarter as well, mostly due to the delay inherent in reporting economic statistics. This lag will hit the economy by hurting consumer optimism with old news as the quarterly statistics (from last quarter) hit the TV news. Some of the more recent data (such as increasing PC sales and improving manufacturing numbers) will offset the bad news, but it will still be a few months before the negative stories leave the "news stream". As before, we recommend keeping a close eye on the longer term trends and serious consideration to fundamental changes in strategy warranted by the shifting global situation in your strategic planning.

Robert Bradford is President of Center for Simplified Strategic Planning, Inc.
He can be reached via e-mail at

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