JANUARY 2004

Economic Growth Ahead,
but Consumer Spending Will Slow

There is much good economic news circulating at the start of this new year. However, expectations of a resurgent consumer sector should be tempered with the knowledge that business investment is driving growth at the moment. Consumer spending has benefited from tax cuts and the record-setting mortgage refinancing boom, but those benefits will play out early in 2004 and will not be repeated. Readers of this column will recognize this theme from previous issues. The economist research team at Goldman Sachs admits that they are out of the consensus with this view, but their logic seems sound.

First, real (inflation-adjusted) capital spending is already accelerating at about a 4-5% annual rate, and the Goldman Sachs team expects it to reach 10% or higher for all of 2004. But, more importantly, the current budgetary climate in Washington has swung from massive fiscal stimulus (tax cuts, increased spending on defense, Iraq and the war on terror), toward mild restraint. And, the winding down of the refinance boom means that homeowners will cash out less home equity than was the case in 2003.

They summarize the implications for various sectors as follows: "Over the next year we expect capital spending to outperform consumer spending substantially. If history is any guide, this should lead to a significant out performance of industrial vis-à-vis consumer stocks." That means that stocks in manufacturing company stocks (machinery, electrical equipment and multi-industry stocks) will likely do better than stocks in companies that depend heavily on retail sales and consumer goods. In particular, the slowdown in growth in consumer spending will be "most problematic for automobile sales. Detroit is all "bulled up" on a 2004 economic recovery, leading the Big Three automakers to forecast higher sales and improved pricing. But, sales are already quite high, and pricing is likely to get worse, not better. Supply is likely north of 16.7 million units, but we forecast demand at 16.4 million. This leaves 0.3 million units to be cleared by a 2% decline in price."