Stocks soar, but investors worry

0 Comments | Insight on the News, Oct 20, 1997 | by Gene Koprowski

More people than ever have money in the market, and many are jittery about fluctuations. Economists, however, are finding it difficult to forecast trends.

What does the decrease in corporate-earnings growth imply? What are investors to make of wage gains among skilled workers? Is a stock-market correction -- or even worse, a crash -- coming? Federal Reserve Board Chairman Alan Greenspan, in his own abstruse way, summed up the opinion that economists increasingly are taking when it comes to answering these persistent questions.

"Most recently, the economy has demonstrated a remarkable confluence of high resource utilization and damped inflation," said Greenspan during remarks at Stanford University in September. "Once again we have been faced with analyzing and reacting to a situation in which incoming data have not readily conformed to historical experience."

In other words, today's economy is harder to forecast. No precedent exists for the kind of growth the United States has undergone since the early 1980s, nor for the drastic changes the country experienced as it transformed itself from an industrial to a technological powerhouse. Economists are grappling with new figures, monthly and quarterly, looking for signs and signals. But no one is really sure what indicates pending doom.

Take the question about corporate earnings, which obsessed Wall Street during September. Second-quarter earnings forecasts from the largest companies in America, including Microsoft, General Electric and General Motors, increased by an average of just 1.3 percent.

This shocked economists such as Brian Wesbury, vice president of Chicago's venerable investment bank Griffin, Kubik, Stephens & Thompson Inc., which noted that profits rose only, 4.3 percent in the first three months of the year, itself a slowdown.

"During the 16 quarters ending in June of last year, profits rose at a 12.5 percent annual rate," Wesbury tells Insight. "In the past four quarters, corporate profits are up only 5.1 percent, a significant slowdown. With profit growth slowing, the stock market is vulnerable to further correction."

In the past this may have been a leading indicator, for earnings slowdowns meant prices of production were rising. Since wages constitute two-thirds of the cost of most manufactured products, an earnings slowdown might signal that employee costs are rising. But, economists caution, in the absence of measuring tools for the new economy, no one can draw the same conclusions they may have in the past.

"We simply do not know if economic growth is changing for the worse yet," says Michael Farr, president of Farr, Miller, a Washington-based investment-management firm. "It appears we are seeing the beginnings of a slowdown in earnings. But it is too early to tell. We need more data."

One reason for this: Worker productivity in the new era is difficult to measure. As Greenspan noted, it is quite simple to measure the output of tons of cold rolled steel and copper wire per day per worker. But the question of how to measure the productivity of software creators or medical innovations is perplexing. Much of the growth in the economy is hidden and cannot be foreseen from quarter to quarter. "It will take years to measure the changes," says Farr.

To be sure, many economic signals remain valid. Consumer bankruptcies have increased, and that is a sign that there will be a spending slowdown somewhere along the line. Real-estate prices are holding steady, meaning inflation isn't out of whack. The downsizing trend has disappeared, and job growth remains strong. Fundamentally, the economy is still growing.

Until economists come up with new tools to measure the new economy, though, they will differ in their interpretations of the data. Maybe the earnings decline that so upset Wall Street and Washington isn't a leading indicator, but a trailing one.

"We put corporate America into a fitness program during the 1980s and early 1990s. We got leaner and meaner as an economy," concludes Farr. "But now our economic expansion iS approaching middle age, and like all beings at middle age, has to work harder just to stay in shape."