ECONOMIC PERSPECTIVE
Prepared by Merrill Lynch & Company
Global Securities Research & Economics Group(November 17, 2000) With the election result determined, investor attention will now focus on the incoming administration's economic program, its potential for being legislated, key appointments and, as always, the path of the economy. In the weeks immediately preceding the election both market developments and data increased our confidence that growth has slowed to a level at or below the potential growth that could be achieved without accelerating inflation. The aftermath of the election will not change that. If anything, the end of election-related jobs and spending and the impact of the election stalemate on consumer confidence will reinforce the tendency to slower growth. More than $4 billion was spent on campaigning and advertising, much of it in the final month of the campaign and this injection will now stop. However existing data on growth and employment following past elections suggest the impact is small.
The key to the slowdown is slower growth in consumer demand from the robust 4.5% pace of the third quarter. While construction spending is holding up well, in general, retail sales, especially auto sales have gotten off to a slow start. We expect that retail sales were down 0.5% in October. Further, inventories have been building faster than underlying demand for the past two quarters and a somewhat slower build will likely subtract from headline growth this and/or possibly the next quarter. Government spending will likely rebound and contribute to growth. Offsetting this will be a limited further deterioration in net exports due to the continued strong dollar and a further slowing of the still healthy growth in investment. On balance, then, headline growth will probably fall short of the underlying growth in consumer spending. Although the equity market has stabilized from the October sell-off, the rebound is unlikely to contribute to a year-end growth "surprise" as has happened in recent years.
Regardless of the presidential outcome, Congress will likely pass a modest tax cut that includes an increase in the minimum wage. Such a bill nearly passed the current Congress and has bipartisan support. However, such a package would have little economic impact in 2001. There is also bipartisan support for increases in defense and education spending and, at a minimum, defense spending will likely rise in the current (FY2001) budget yet to be passed. However, given both the current difficult relationship between the political parties and the president's limited mandate the size of any tax cut will be considerably less stimulative than the $1.3 trillion campaign rhetoric promised. Further, a tax cut will be phased in and will, in part, be directed to savings incentives.
While their approach may differ with regard to details, both presidential hopefuls are basically business-friendly and advocates of free trade. A Bush administration is likely to be more broadly supportive of further deregulation and business incentives, while a Gore administration would likely target its support to technology. Further, given the close election, Gore would have to yield to the reality that union support was a critical factor in the outcome. Regarding trade, Bush would likely give priority to hammering out a free trade agreement with key Latin America countries while Gore would emphasize labor and environmental reform in future agreements. Both would seek fast track authority from Congress.
On balance, then, our forecast for a slowdown in the economy remains intact, and growth is likely to be below potential for two to three quarters. Longer term, limited spending increases and tax cuts coupled with a modest decline in rates is likely to help keep growth on a solid pace. However, key appointments in Treasury and the National Economic Council have yet to be made. An assessment of these and of what can be achieved with a razor-thin Congressional majority will guide our ongoing analysis.
(Reprinted by permission. Copyright 2000 Merrill Lynch, Pierce, Fenner & Smith Incorporated.)
November 17, 2000 David Horner Merrill Lynch & Company Global Securities Research & Economics Group North Tower, 21st Floor World Financial Center, New York, New York 212-449-1854
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