Solid Outlook for '05

Economists Expect a Strong Year for the U.S. Economy, Though Overall Growth Will Slow Compared to 2004

By Phillip M. Perry, Contributing Editor -- Industrial Distribution, 1/1/2005

Let the good times roll. Thanks largely to a rebounding national economy, many businesses are coming off a healthy 2004.

"We have seen a significant turnaround from the period of 2001–2003 when our members were hit hard," says Michael Smeltzer, director of the Manufacturers' Assn. of South Central Pennsylvania, a trade group whose members represent a broad range of industries. A federal tax strategy that energized consumer confidence and the depletion of inventories in the supply chain were contributors to the turnaround, he says.

Other observers, such as Sophia Koropeckyj at Economy.com, a research firm based in West Chester, Pa., cite as positive forces a stronger global economy lifting all ships and a weaker dollar spurring exports. Also, a rebound in capital spending was spurred by lower interest rates. Finally, healthy corporate balance sheets enjoyed a stimulus from accelerated depreciation allowances.

Many observers believe we are heading into a healthy period for revenues and profits. Smeltzer is one who foresees a strong year, especially in the capital goods marketplace.

"The consumer goods marketplace may soften a bit because there is concern about the amount of discretionary income," he adds.

By early November, the Institute for Supply Management was reporting continuing strong growth at the nation's manufacturers, but at a rate slower than that of the first three quarters. While new orders and production remained strong, energy prices and commodity price inflation were major concerns.

Koropeckyj puts it this way: "The next 12 months should be pretty good for manufacturers—not as strong as 2004, but otherwise the best year since 2000."

Many business owners are cheered by the recent presidential election. Republican domination of Congress seems to promise the reinforcement of a fiscal policy favoring business tax breaks to promote a strong economy. Retailers, in particular, favor the continuation of a low tax policy, returning more earnings to consumers as discretionary income. Further, President George W. Bush wants to reduce the costly paperwork required for tax compliance.

On the legal reform front, business owners are applauding the Bush administration's pledge to push legislation reducing the incidence of costly medical lawsuits, which are seen as driving up the cost of health care for employers.

Finally, the president is not expected to take actions to discourage the corporate outsourcing of work to other nations—a practice seen as partly responsible for a reduced cost of production that translates into lower shelf prices.

Most economists anticipate a slowdown in 2005. Rising oil prices are a major reason. Also expected to contribute to the cooling down on the business spending side is the expiration of the liberal depreciation allowance, along with a softening of export activity from a less dramatic decline of the dollar against the Euro and Chinese Yuan. Finally, not only did consumers fail to shop as aggressively as anticipated during the second half of the year, but consumer confidence took a serious dip in late summer as people reacted to high energy prices and lackluster job growth. The expected rebound in quality hiring did not occur in 2004, and that failure, along with the long-term decline in job totals over the last four years, has put a serious crimp in the consumer goods side of the economy.

Recent reports, though, seem to cast a glimmer of light onto the formerly gloomy 2005 picture. By the time Thanksgiving rolled around, business owners were getting cheerful news on a number of fronts:

• Non-farm payroll employment increased by 337,000 jobs in October, far above market expectations of about 175,000.
• Industrial output increased 0.7 percent in October, more than double the analysts' expectations of 0.3 percent.
• Housing starts jumped a larger-than-expected 6.4 percent in October to the busiest pace since December 2003.
• Consumers sent a rebounding message the same month, as sales bumped up 0.9 percent compared with forecasts of a 0.5 percent gain.
• Consumer confidence seemed to rebound from its relentless softening as The University of Michigan's November survey advanced to 99.5, up from 91.7 the month before.
• Oil prices declined to less than $50 a barrel, promising less upward pressure on gasoline prices.

No prudent economist places too much credence on one month's data, and few anticipate that 2005 will match 2004's achievement of a 4.4 percent increase in gross domestic product. Even so, the array of good news caused many to brighten their forecasts. Morgan Stanley, for example, revised its 2005 forecast for GDP to 3.9 percent, up from the former 3.4 percent view.

If predicting the future is a difficult task, the unsettled price of raw materials makes matters even riskier. Many businesses are keeping a wary eye on the price of oil and the price of raw materials associated with it. Both of those are critical and could seriously impact the economy.

It's no secret that the rising cost of steel has been a thorn in the side for much of American business. Yet a softening of demand may offer at least some relief. Some economists now forecast China will boost interest rates as much as 2 percent in 2005, putting a crimp on runaway business expansion and reducing that nation's demand for steel.

Says Koropeckyj, "Our forecast is that very high steel prices will start to ease next year, partly because the Chinese government has been trying to slow that nation's economy."

Understanding oil prices and raw materials is tough for anyone to do right now because they are interdependent with currency values. Anticipation of higher oil prices has served to push up the value of the Euro over the dollar.

Productivity is on the rise at manufacturers everywhere. Koropeckyj expects that to continue.

"There really has been a trend to favor substituting machines for workers. And as interest rates rise, it will be even more cost effective to introduce more labor-saving equipment," she says.

Many observers hail productivity gains as a sign that American industry is laying the groundwork for future strength. Manufacturers and other businesses have increased productivity by introducing new efficiencies and keeping payrolls slim. They've hesitated to add people partly because of the resulting financial penalties incurred from additional health care and pension obligations.

There's another reason for holding back on new hires: uncertainty about what lies ahead.

"One of the biggest wild cards for 2005 is the fragile nature of business confidence," cautions Koropeckyj. "Businesses are not assured that we are on the strong path of recovery. Business confidence is unquantifiable, but can cause employers to hesitate to spend."

Businesses are in a good position to thrive in 2005. Productivity gains have made them lean profit machines, although everyone will be watching the price of commodities such as oil and steel.

So we're looking at a forecast of "partly cloudy, little chance of rain." No need to take an umbrella to your office. But toss one in the back seat of your car.

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