The state of the US economy is a vital influence on almost all businesses’ success, wherever they are based. But at the moment, commentators are far from agreed on what’s going to happen – making a realistic evaluation of the economy’s prospects all the more necessary. Datamonitor’s Brendan Ford weighs up the evidence…
Early this year, the US economy looked like it might be beginning a significant recovery. But more recently, the outlook has soured. Stock markets have fallen, and many say that Q1’s increased growth was not representative. There are presently three schools of thought on what will happen next – optimists, pessimists and moderates.
The optimistic school holds that the economy is poised for a moderate rebound into the realm of respectable growth by the middle of the third quarter. They point to strong Q1 GDP growth and believe that increased business spending will drive the recovery.
The pessimistic school, meanwhile, predicts a ‘double-dip recession.’ Stagnant business investment and jittery foreign investors will prevent an economic upturn and the weak job market will eventually lead to a reduction in consumer spending causing a second economic dip before the start of any recovery.
The moderate school, unsurprisingly, falls in between the two camps. Moderates foresee foresees steady consumer spending and stagnant business investment leading to a sluggish economy well into 2003.
So who’s right?
An objective look at the evidence presents a mixed picture. The strong US GDP growth in Q1 was indeed a mathematical illusion representing the end of the inventory run-off. It does not represent a return to strong growth, but indicates that the economy is stabilizing. There is no strong indication that B2B spending will exhibit significant growth, as most businesses still have considerable excess capacity.
The mechanisms that triggered economic growth after the last two recessions (sharp interest rate reductions and housing growth in ’84 and a rebound in consumer spending in ’92) are not going to lead the US into a recovery this time around; it is hard to discern any mechanism that will trigger strong growth in the present environment. Therefore it is highly unlikely that the optimistic school will prove correct.
That’s far from an endorsement of the pessimistic scenario: on the consumer front, spending has remained strong throughout the recession despite several dips in consumer confidence. A few months ago, the main consumer confidence indicator had rebounded and was poised to remain strong until recovery.
Dipping into the evidence
However, the latest report by the Conference Board indicates that the US is experiencing a second significant dip in consumer confidence, which is now at a four-month low. Thus far in this economic cycle, spending has not tracked confidence, but if that traditional relationship re-emerges, the US economy will experience a second recession and contract.
Economy watchers should keep their eye on the wild cards that could trigger this ‘second dip’. As accounting practices and ‘reported earnings’ continue to receive closer scrutiny, more companies are being forced to restate their profits. This is a major reason for the recent fall in consumer confidence.
A study by Standard & Poor, which now releases its own ‘adjusted earnings figures’ for many public companies, lends credence to the view that widely-used accounting gimmicks have inflated earnings by as much as 25%. If the capital markets continue to perceive significant gaps between ‘reported earnings’ and ‘real earnings,’ their continued deterioration could trigger a sharp decline in consumer spending.
Moderation – and how to survive it
Despite the accounting scandals, the moderate school still has the highest likelihood of being correct: the US economy will remain sluggish into 2003. The effect on companies’ sales estimates and budget decisions will be heavily sector-dependent. Technology executives, in particular, need to look closely at their industry area.
For tech companies that rely on B2B spending closely related to the need to add new productive capacity, the outlook is poor. If their technology is primarily used to handle existing volume in more cost efficient ways, provide competitive advantage, or facilitate sales and service, business will be sluggish but not dismal, with an upturn in late 2003.
In some areas of IT, Datamonitor’s studies have discovered that external IT spending is gaining at the expense of internal spending, giving vendors a chance to gain in an environment of overall IT budget constraints.
Finally, the weak economy has led to a strong focus on ROI thus directing attention towards solutions where the impact on profitability can be easily quantified and the solution can be implemented quickly and cost effectively.
Vendors still need to break large projects up into manageable stages, each with measurable results. Furthermore, vendors should develop strong financial models that will predict the impact of the project on their clients’ profitability.
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