Vital Signs: Economic Recovery Prospects Improve

9:07 | 26/10/2011

On deck: small business survey, consumer credit, Beige Book, trade deficit, import prices, consumer sentiment, and federal budget

The coming week’s reports will continue to give economists a better idea of how the recovery is shaping up in its early going. So far almost all of the economic data for July have come in well above expectations, including spending by consumers and business, homebuilding, and manufacturing activity. As a result, nearly all analysts now believe the second quarter was the last negative quarter for GDP growth. Many think a bounce in third-quarter growth into the 3%-to-4% range is not out of the question, with plenty of momentum to keep growth moving up in the fourth quarter.

With growth prospects improving, businesses appear ready to start contributing to the recovery—perhaps earlier than in past upturns. Given its austerity of recent years, Corporate America begins this recovery with exceptionally lean inventories, capital budgets, and payrolls. As overall demand begins to turn up, companies will need to gear up quickly.

Extreme corporate caution is also paying off on the bottom line. Based on the Commerce Dept.’s accounting, profits of nonfinancial corporations in the second quarter rose at a 19.3% annual rate from the first quarter. That’s an impressive showing in a quarter when GDP shrank 1%. Profit margins also rose last quarter, primarily reflecting deep cost cutting and sharp productivity gains. Nonfinancial companies are coming out of this recession with margins much higher than at the end of the last downturn. Now, with revenues set to pick up in the second half, further gains in profits are a sure bet.

That’s important, because profits drive corporate expansion. Already, businesses are gearing up output in response to record low inventories. That’s especially true in the auto industry, where a ramp-up in production is expected to account for a big chunk of third-quarter GDP growth. That much is clear from the impressive pickup in manufacturing activity. The Institute for Supply Management’s index of factory activity—a composite of orders, production, employment, inventories, and delivery times—jumped to 52.9% in August, the highest level in more than two years.

But its not just inventories. Prospects for capital spending on new equipment are also looking brighter. After four consecutive quarters of declines, July shipments of capital goods, outside of defense and aircraft, began the third quarter well above their second quarter average. Plus, July production of business equipment rose for the first time this year.

Importantly, as businesses expand, they will also begin to add to their payrolls. Overall employment is not yet ready to turn up, but the diminution of monthly job losses means that some companies have stopped shedding workers. Plus, the workweek ticked up in July for the first time in a year. Businesses tend to increase the work hours of existing employees before they start adding to their payrolls. Companies are on a track toward increased hiring perhaps by the end of the year. That will be a crucial turning point for the recovery’s durability, since any lasting upturn depends critically on consumer spending.

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