Call it the emperor-has-no-clothes recovery theory.
For months, chief executives from General Electric Co.'s Jeff Immelt to United Parcel Service Inc.'s Scott Davis have said that business investment would have to drive the United States' recovery from its worst slump since the Great Depression.
On one hand, their logic is sound: With unemployment hovering near 10 percent, home values almost 30 percent below their peak and consumer confidence weak, people are in no position to step up their shopping.
Companies, on the other hand, last year slashed any cost they could find and hoarded cash amid panic the world was tipping toward a depression. So they do have money to spend. At the end of the first quarter, the companies of the Standard & Poor's 500 index had 10 percent more cash on their books than a year earlier, according to Thomson Reuters data.
"Clearly, this is a business-led recovery," UPS's Davis said last week. "You'll see industrial production grow faster than GDP. That's driven by the manufacturing side."
The problem, investors and executives say, is that they're afraid to spend it until consumers start buying again — and not without reason, given that in the United States consumer spending accounts for more than two-thirds of economic activity.
That trend was illustrated on Wednesday when Rockwell Automation Inc., which makes systems to help factories run more smoothly and at lower cost, reported results. It beat Wall Street's profit target and raised its forecast for the year, but its shares fell after the company reported that customers in the United States and Europe were trigger-shy on starting major capital projects.
"There is just too much uncertainty, so people are delaying decisions," CEO Keith Nosbusch said in an interview.
Manufacturers have done well so far this year, reflected in rising profit at companies including United Technologies Corp., Caterpillar Inc. and 3M Co. But the fact that not even that sector is ready to invest in equipment raised worries about the sustainability of the economic recovery in the eyes of Nosbusch and investors.
"Business led this one, but business can't sustain it alone," he said. "Because consumers make up such a large part of the economy, it is not sustainable without the consumer participating."
Two main factors pushed up manufacturers' revenue in the first half.
Consumption in Asia, which only slowed during the recession, ramped back up sharply, while their customers in the United States needed to rebuild inventories that they had slashed as they conserved cash last year.
Only the first of those factors points to sustained demand.
"Not everybody is going to be able to export their way out of this," said Peter Sorrentino, senior vice president and portfolio manager at Huntington Asset Advisors in Cincinnati. "Unless there's a follow-on, we're going to hit an air pocket, where maybe you don't go into a double-dip recession, but you can't get enough critical mass going to ignite consumer demand and replace what has been a very modest industrial-led recovery so far."
This has investors worried — reflected in the shares of companies including GE and Boeing Co., which fell even after they reported better-than-expected profit.
"The perception is that there has been a pull-forward of economic activity," Sorrentino said. "These things are slowing and they're slowing to such a degree that you take it the next step out and you get to a flat line."
Without a pickup in consumer spending, investors are worried that the growth companies are reporting now will peter out in the quarters ahead.
"Let's face it, the recovery ain't anything to write home about," said Peter Klein, senior portfolio manager at Fifth Third Asset Management in Cleveland. "Ultimately for the GDP of the country to expand, you have to have consumers participate."
So far that has not happened. Major U.S. retailers' June sales were slightly lower than Wall Street had expected, and worryingly, investors feared that heavy promotions that month put July's sales in jeopardy.
Wall Street is looking past manufacturers' strong results of the early part of the year and worrying that companies will not be able to keep that momentum into 2011.
"That's why the market fell off in the spring and summer here. There's a lot of doubt that it's going to happen," Klein said. "People's expectations ramped up that recovery is going to happen tomorrow and now it looks like it's not to going to happen for another two quarters, four quarters. And that's a long time."
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