Stocks Dip; Economy Gains - Inch by Inch

THE United States economy and the stock market are going in opposite directions.

"That's not uncommon," notes Michael Keran, chief economist of the Prudential Insurance Company of America.

Stock prices dropped 69.01 points last week to 3,285.25, as measured by the Dow Jones industrial average. There were stock sell-offs also in Mexico and Tokyo. But economists expect US economic output this year to grow on average a modest 2.1 percent after inflation. Even the pessimistic ones figure the recession has ended.

"If you look beneath the surface, things are terrible," says one such pessimist, Philip Braverman of DKB Securities Corporation in New York.

Last week's statistics, however, show an economy still moving up slowly. Industrial production increased 0.6 percent in May. Builders broke ground on new homes at an annual pace of 1.23 million in the same month. That was up 11 percent from the previous month when housing starts were off 17.3 percent.

A new survey by the 12 regional Federal Reserve Banks concluded: "Economic activity continues to improve." Manufacturers are enjoying more demand for their products in all parts of the country, the survey found.

Further, productivity increased in nonfarm businesses at an annual rate of 2.7 percent in the first quarter. The nation's standard of living improves only if there are gains in productivity.

To Dr. Keran, such numbers are evidence that his relatively cheerful forecast for the economy of growth at a 3 percent annual rate in the first half and 4.5 percent rate in the second half is likely to be proved correct. Though unemployment rose to 7.5 percent in May from 7.2 percent in April, Keran expects the jobless rate to fall to 7 percent by the end of this year and to 6 percent by the end of 1993. He forecasts inflation at a 3 percent rate.

Less encouraging was a jump in the US trade deficit to a 17-month high of $6.97 billion in April. Exports fell sharply while imports shot up to the second-highest level on record.

RETAIL sales inched up only 0.2 percent in May after rising just 0.4 percent in April. Since February, notes Mr. Braverman, retail sales have declined after inflation at a 5.6 percent annual rate. Retail sales account for 68 percent of gross domestic product (GDP).

"Nothing is going great guns," he says. "It is going to feel like a recession."

The downturn in the US stock market was anticipated by Keran. Stock prices in the Group of Seven major industrial democracies declined 14 percent (after taking account of inflation) from their average in 1989 through last Monday, he notes.

But in the US, real prices had risen 15 percent.

"The US is way out of line with every other industrial country," he says. Keran anticipates a drop in the Standard & Poor's 500 index from an average 412 in the first half of this year to around 350. One trigger could be corporate earnings growth of around 20 to 30 percent rather than the 40 to 60 percent anticipated by many investors, he says.

A worrisome factor for some economists is the slow growth in M2, a measure of money that includes currency, checkable deposits, and savings and small denomination time deposits. In the past three months M2 has increased at a rate of only 1.7 percent, well below the target of Federal Reserve policymakers.

"As far as Federal Reserve officials are concerned, economic growth seems to be about the last thing that enters their mind," complains Sam Nakagama, a Wall Street economist. "Their primary goal seems to be that of getting inflation down to zero."

Some other economists maintain that rapid growth in a narrower measure of money, M1, assures continued prosperity. Money growth is seen by economists as the necessary fuel for economic growth.

But Mr. Nakagama says, "There is no monetary aggregate or economic series that has a closer relationship with GDP growth than M2. The Fed should be trying to maintain M2 growth."

Paul Kasriel, an economist with Northern Trust Company in Chicago, agrees: "It is a critical issue. We could very well see this recovery dying out in the third or fourth quarter, if not sooner."