Why US economy is poised to lift out of negative GDP

The pathway out of recession may be finally becoming clearer.

True, the economy was still contracting between April and June, as the Commerce Department reported Friday. The nation's gross domestic product (GDP), a broad measure of overall production of goods and services, declined in the second quarter by a 1 percent annual rate.

But the GDP report also suggests, say some economists, that the economy is poised to move into positive territory. Here's what they see as good omens.

• Businesses have let inventories fall so far that they are going to have to begin placing orders to fulfill customer demand.

In the last two quarters alone, inventories declined by more than $255 billion – a record pace.

“The amount drawn down has been awesome,” says economist Joel Naroff of Naroff Economic Advisors in Holland, Pa. “It’s as if business has said, ‘If they need it, we will go and get it, but we won’t have it around.’ ”

But at some point, businesses must replace inventory. “In terms of the potential for the economy, once demand picks up it has to trigger additional production,” says Mr. Naroff.

• Consumer spending fell in the second quarter, but anecdotal evidence indicates that may be starting to change.

The second-quarter drop was 1.2 percent, at an annual rate, compared with a gain of 0.6 percent in the first quarter.

But the “Cash for Clunkers” program, for one – in which owners of gas-guzzling, emissions-spewing vehicles get cash incentives to trade them in for new fuel sippers – appears to be successfully attracting customers to new-car lots. On Friday, the House of Representatives voted to add another $2 billion to the program.

Data show, too, that more people are starting to buy houses, especially foreclosed properties.

“If consumers are willing to buy big-ticket items, they may buy more of the little things that may make them feel happy,” says Naroff.

• Government spending is expected to continue. It was the only area of positive growth in the second quarter, and the stimulus legislative virtually assures that government will help prop up the economy.

“In 2010, that’s when we will get the most affect of the stimulus spending on the economy,” says economist Sung Won Sohn at the Smith School of Business, California State University, Channel Islands.

Although GDP was negative in the second quarter, it fell much less than the first-quarter drop of 6.4 percent (revised downward from the earlier estimate of 5.5 percent). The sharp change is prompting some economists to wonder if the economic rebound in the second half might be stronger than expected.

“When you get a steep downturn, typically you get a robust recovery,” says John Canally, chief economist at LPL Financial in Boston.

President Obama seized on the Friday report as as indication “that in the last few months the economy has done measurably better than we thought.” But he also said that the sharp downward revisions from earlier GDP numbers, including those for 2008, indicated “the recession we faced when I took office was even deeper than anyone thought at the time.”

Economic comparisons will probably improve in the months ahead, says Mikel Keifer, a vice president of Jurika, Mills & Keifer, an Oakland, Calif.-based investment adviser.

“Starting last October, there was just a complete stoppage in the economy after Lehman Brothers failed and Treasury Secretary [Henry] Paulson was appearing before Congress and screaming the world would come to an end if they didn’t act,” says Mr. Keifer. “Next quarter [the 4th quarter] is going up against that.”

Keifer says his biggest concern is that the economy will not have any dynamism even if it recovers. He points to consumers who are still in shock over the events of the past year.

“A lot of consumers have adjusted their spending and savings rate, bringing their spending down,” he says. “It’s the new reality, as everyone likes to call it.”

Over the longer term, Keifer says, he is concerned about the economy starting in 2011. “There is a massive amount of [federal government] debt built up,” he says. “It could create an inflation problem or be a general drag on the economy. It’s still a ways out, but we could have a very negative period.”

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