The U.S. economy will begin its 10^th year of economic growth in April. By February, this expansion will already go down in the history books as a record in terms of duration in this post-war (World War II) era.

In the past, some economists have tended to predict upcoming recessions after economic expansions lasted three or four years simply because "it was time." But economic expansions don’t die of old age. Recessions are generated by a variety of factors – often a bout of inflation, which causes Federal Reserve officials to tighten monetary policy and sharply raise interest rates.

Among Wall Street economists today, only one is predicting a recession this year. No, it isn’t Ed Yardeni of Y2K disaster fame. Mr. Yardeni withdrew his recession forecast on January 3 and is now predicting that the economy would expand smartly in 2000. A majority of economists expect that growth will moderate in 2000 from the heady pace of the past several years – and they anticipate the Federal Reserve will be tightening monetary policy in order to ensure such an event. Let’s look at the predictions compiled by the National Association for Business Economics at the end of last year by their key business forecasters in order to see how the economic outlook will affect your investment opportunities in the months ahead.

In the "old days", economists and policymakers believed that the U.S. economy could sustain a long-term growth rate of 2.5 percent per year. After revisions to the national income and product accounts in 1999 when the Commerce Department began to incorporate software expenditures as investment, history was re-written and new beliefs came to the forefront. Now, conventional wisdom holds that real (inflation-adjusted) GDP can grow 3.2 percent a year without generating inflationary pressures.

Between 1995 and 1999, real GDP grew at an annual average of 3.8 percent – faster than the "new" sustainable long term average. This is exactly what has placed Fed officials in a high state of alert for the past year. The NABE economists are predicting that real GDP will slow to a 3.2 percent rate in 2000.

While not as robust as the past few years, this rate of growth will generate corporate profits on the whole. This means that equity values may increase in the coming year as well. But most market mavens aren’t predicting the kind of spectacular gains we saw in the past several years. Incidentally, the NABE forecast panel didn’t make any stock market predictions.

Consumer spending accounts for two-thirds of economic growth in the United States. Yes, we are an insatiable consumer society that thrives on borrowing and dis-saving. Consumer installment debt burdens were at all-time highs by the end of 1999 while the personal saving rate stood at all-time lows. Consumer spending was spurred by stock market euphoria. Homeowners, a large segment of the population, also benefited from housing appreciation these past couple of years – adding to their (paper) wealth. Consumer spending grew a whopping 5.1 percent in 1999. The forecast for 2000 appears practically anemic by comparison! Yet, the 3.5 percent growth predicted for this coming year still compares favorably with the long-term average.

There is no question that a good chunk of expenditures came from the consumer’s love affair with new cars and sports utility vehicles. Motor vehicle sales grew steadily through the late 1990s, but nothing compared with the 1999 pace. It seems almost unbelievable that 2000 could bring one more year where auto and light truck sales are in the same ballpark. Indeed, the NABE forecast panel is predicting only a moderate decline of 4.8 percent in 2000 to 15.9 million units from 1999’s record year of 16.7 million units. Only 1986 came close to this level when sales were boosted by extreme incentive plans.

In 1999, housing starts reached their highest level in 13 years. This was a good year for the housing market, but housing starts don’t begin to show the extent of the soaring market. Sales of new and existing homes reached record levels during the year. Until the 1990s, 1977 and 1978 were the two strongest back to back years on record for new home sales. Levels in 1998 and 1999 surpassed these by nearly 10 percent. The existing home sales market was also skyrocketing these past couple of years. The previous two strongest years were recorded in 1978 and 1979 – until sales for 1998 and 1999 surpassed these two records by more than 30 percent!

The flaming housing market helped to propel spending on furniture, appliances, and home furnishings. Since spending on furniture and appliances can lag housing investment by a few months, it wouldn’t be surprising to see some further gains in this market in the early part of 2000. But as housing demand diminishes from the soaring levels of the past couple of years, we could see a moderation in furniture as well.

Business fixed investment, which includes spending on producers’ durable equipment & software, and nonresidential structures, expanded 10.5 percent per year between 1995 and 1999. Information processing equipment and software accounted for a good portion of the gains in recent years. In 1998 and 1999, transportation equipment also boosted capital spending. Now that the Y2K bug scare is over, businesses are likely to shift their capital expenditures dollars. However, that doesn’t mean that spending on new technology will stop. Economists are predicting a moderation in investment spending in 2000 to show a respectable 8.3 percent gain. To some extent, the slower spending on fixed investment will stem from slower growth in after-tax corporate profits. The NABE panel predicts that profits will increase 4.4 percent in 2000 – about half the pace reported for 1999.This is certainly better than the 1998 showing when profits actually declined. Profit growth had been healthier from 1995 to 1997.

With the exception of 1980 and 1981, real net exports were negative in every single year since 1959. That means that U.S. consumers and businesses purchase more foreign goods than the United States exports. It acts as a drag on GDP because as long as we are buying imports, they aren’t produced in the U.S. and can’t be counted in our measure of production.

Given that net exports are always a drag, then it matters whether they are a bigger or smaller drag! In recent years, the biggest deterioration in real net exports came in 1998 and 1999. The net export deficit for 2000 is expected to widen only moderately. The slower rate of deterioration is coming from a pick up in export demand from Europe and Asia. This means that we will see a shift in production in the United States. Indeed, industrial production already picked up steam towards the end of 1999. The NABE economists expect industrial production to accelerate in 2000 from 2.5 percent to 2.9 percent. This bodes well for U.S. manufacturers – particularly those already in the export market.

The civilian unemployment rate averaged 4.2 percent in 1999 – the lowest level in 30 years. It was the fourth straight year in which the jobless rate fell below the magic level of 5.5 percent, that is, the level of unemployment previously associated with "full employment." In the old days – prior to the "new economy" paradigm, economists and policymakers believed that inflationary pressures would come into full force when the unemployment rate reached 5.5 percent. While wages undoubtedly accelerated in 1995 and 1996 when the jobless rate decreased, wage increases were matched by productivity gains. When productivity rises, wage gains are not inflationary, and generally not passed on to consumers in the form of higher prices for goods and services. Productivity is expected to increase 2 percent in 2000, slower than the 2.7 percent hike recorded in 1999. If wage gains don’t moderate in tandem with productivity, inflationary pressures are more likely to develop. Economists are now predicting that the jobless rate could tick up a notch to 4.3 percent in 2000 as slower economic activity reduces the demand for labor. This might help quell wage demands.

Inflation was at its lowest rate in 1998 measured by both the consumer price index and the GDP price deflator. A surge in oil prices boosted both measures in 1999. Economists are predicting a slight upward tilt in inflation in 2000 as well. This could come from stronger demand for manufactured goods – commodity prices other than oil did pick up a bit in the producer price indices. In any case, the inflation forecast is not ominous. The CPI is still expected to rise only 2.5 percent, while the GDP price index is predicted to increase 1.6 percent. The GDP price index measures changes in the composition of output as well as changes in prices. It isn’t a fixed basket of goods like the CPI. As a result, it reflects the attempt to shift to lower priced goods by consumers and businesses. As a result, it measures a lower inflation rate than the more widely quoted consumer price index.

Interest rates rose in 1999, and are expected to rise further in 2000. The Fed raised its federal funds rate target three times in 1999 by 25 basis points each time. This pushed the federal funds rate to 5.50 percent by year-end. Economists are now predicting that the Fed will raise its target rate at least two more times in 2000, with the first 25 basis point rate hike to be announced at the conclusion of the February 1 & 2 FOMC Meeting. The expectation of tighter monetary policy has already led to a surge in interest rates in December and early January. The NABE forecast panel predict that the 30-year bond will average 6.2 percent in 2000. The rate stood at 6.6 percent in mid-January. Thus, the forecast implies some moderation in interest rates later in the year.

Rising interest rates could curtail the soaring equity market. Higher rates can generate a shift in investor dollars from stocks to bonds. In addition, higher interest rates generate lower valuations of future earning streams – and depress stock prices.

Economic growth, inflation and interest rates are variables that will no doubt impact the investments in your portfolio. Some general rules of thumb can be followed given this year’s outlook. Economic growth generates profits. If this panel’s forecast were realized, it will mean slower economic activity and slower profit growth. Slower growing profits could dampen equity prices. A rising interest rate environment is generally bearish for the equity market. First, the underlying value of a company’s income stream is reduced at higher interest rates. Furthermore, higher interest costs become higher expenses paid by companies – curtailing profit growth. A general increase in the rate of inflation is also negative in that companies need to raise product prices or find reduced profit margins.

This doesn’t mean that opportunities for profitable investments will be nil in 2000. Indeed, the shifting composition of economic output will lead to market rotation of industries, which are in or out of favor. Putting tech stocks aside for the moment, an increased demand for U.S. exports favors manufacturers’ in general. While housing construction could remain near current levels, the downward drift in this industry may dampen the prospects for construction and furniture stocks.

The economic outlook can set the framework for finding new investment opportunities. However, it is important to remember that well-managed companies often march to the tune of their own drummer – particularly if they are gaining market share in a profitable manner. Home Depot is a striking example of this phenomenon. Economic fundamentals would have suggested falling values for this company’s stock as housing construction moderated and interest rates rose in the past several months. Yet, Home Depot’s stock price marched ever upward during this period.

In contrast, bank stocks were all hit in recent weeks by rising interest rates. The management problems faced by Bank One has led the price of this company’s stock to plunge much more dramatically than its peers. This reveals how important it is for investors to follow economic, industry and company fundamentals in order to invest in a more prudent and profitable manner.