The Economy Is Brighter Than the Figures Show

Consumers still have enough oomph to keep the expansion going, despite housing and gasoline woes. And businesses are showing unexpected strength.

By Peter Goldstein, Senior Economics Editor, The Kiplinger Letter

May 31, 2007

Dismal growth figures for the first quarter will rev up recession talk. The downward revision for economic growth in January through March, to 0.6% from the previous estimate of 1.3%, marks the slowest pace in four years.

But we're not about to sound the slump alarm. The most recent figures overstate the economy's level of weakness. Note that a surprise surge in imports during March knocked a good chunk out of gross domestic product -- imports are a negative in the economic equation. But import gains cut two ways: They also show that American consumers and businesses are continuing to buy stuff, even though at lot of the stuff comes from abroad. This isn't typical of an economy grinding to a halt.

Still, though a recession isn't likely, economic growth will certainly be meager for the rest of this year, hovering around a 2% pace. Lofty gasoline prices are compounding the sting from the housing slump, which will continue well into 2008. This year, average house prices in the U.S. are poised to fall about 4%, while housing starts will total only about 1.45 million.

Meanwhile, the pain at the gas pump will dent consumers' purchasing power. The $1-a-gallon jump since January is the equivalent of an $80-billion tax on consumers, and soaring food prices will likely levy $30 billion more. As a result, growth in consumer spending is dialing down to a modest 2%-2.5% pace from 4.4% in the first quarter.

Happily, businesses are showing unexpected resilience. Business-to-business orders are holding strong, helped in large part by exports, as robust economies in Europe and Asia plus the falling dollar play to U.S. companies' favor. Managers in manufacturing say they're upbeat about the months ahead. To prepare, firms are adding to inventories, which will be a positive for economic growth in the current quarter and over the summer. Companies will also continue to hire more workers, albeit cautiously. The economy is still on course to add about 1.3 million jobs this year, helping to underpin consumer spending.

Of course, some sectors will fare far better than others in an economy that trudges along at a sluggish pace. The big losers are likely to be vendors of big-ticket consumer products, such as autos and home electronics, which households can easily delay purchasing. Businesses that depend on home building, such as mortgage finance firms, furniture and fixtures sellers, electrical service providers, plumbers and lumber companies, are also in trouble.

Meanwhile, the energy sector will thrive amid brisk global demand for fuel. Producers of specialty chemicals, primary metals and steel will also feed off a snappy global economy, as will major export industries, such as heavy machinery and aerospace. And the future is bright for health-related industries, such as medical equipment manufacturing, plus brokerages and business service firms that help companies cut costs by outsourcing key functions.

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