Forecast: Where do we go from here?

February 15, 2002: 3:55 p.m. ET

Five barometers pointing the way for the economy and the markets.
By Staff Writer Mark Gongloff

NEW YORK (CNN/Money) - The "perfect storm" that hit stock prices and the economy in 2001 seems finally to be passing -- but the sun isn't exactly shining yet.

Stocks have rebounded smartly from their troughs in the aftermath of Sept. 11, but merely to the so-so levels in place before the attacks. When the first three trading days of 2002 brought strong gains, some observers hoped a lasting rally was on the way.

But stocks fell on the fourth day, were mixed on the fifth, and the see-saw pattern has continued in the weeks since, with the Dow regularly flirting with 10,000 and then quickly retreating.

While evidence of an economic recovery has been consistent, less-than-thrilling corporate profits and the revelation of accounting irregularities at Enron Corp. and other companies have held back the stock market.

Unfortunately, major indicators point to more of the same in 2002. A recovery in the economy and corporate profitability seems almost certain, but gains will be muted by sluggish demand, mounting consumer debt, and concerns about corporate accounting and finances.

"The recovery of 2002 looks poised to mirror the recovery of a decade ago, with a moderate economic and earnings recovery following a short and shallow recession," said Anthony Chan, chief economist at Banc One Investment Advisors.

While economists and market watchers have hundreds of indicators to help them predict the future, here are five of the biggest issues to consider:

Consumer spending

Current conditions: Sunny

Consumers rule the U.S. economy, fueling two-thirds of gross domestic product (GDP), and recent data have indicated they are as willing to spend as ever.

Though the University of Michigan's consumer sentiment index reportedly fell Friday, the Conference Board's confidence index has risen steadily in recent months, and retail spending has held strong. Though unemployment is still high compared to its pre-recession levels, the pace of job cuts seems to have slackened recently, boding well for consumer spending in coming months.

But there's a downside to this resolve. While consumers have held this recession in check, mounting debt levels means it's unlikely they'll be able to spend much more to fuel a robust recovery. A sluggish stock market could also keep consumers on the sidelines.

Business spending

Current conditions: Partly cloudy

If consumers aren't going to fuel a recovery, then businesses will have to -- after all, they started the recession when they snapped their wallets shut at the end of the spending boom of the 1990s. Too much spending led to too much production capacity in factories, too many unsold goods on shelves, and too little business demand for those goods.

As a result, the manufacturing sector sank into a recession from which it still hasn't recovered, according to reports from the nation's purchasing managers. But even those reports have shown steady improvement in recent months, and the Commerce Department says inventories are steadily dwindling, meaning production can pick up again some day -- but only when demand picks up, and there's no telling for certain when that will be.

The Fed

Current conditions: Sunny

The U.S. central bank has showed the rest of the world how monetary policy should be run, aggressively keeping interest rates low during the downturn, which makes the cost of borrowing cheaper for consumers and keeps them spending. The Fed's recent decision to leave rates alone demonstrated their cautious optimism that the economy could be close to a recovery.

Even the Fed's warnings that the risk of weakness still exists can be seen as positive -- it means policy makers likely won't be raising rates any time soon, a good thing for consumers and the stock markets.

Corporate profits

Current conditions: Partly cloudy

Earnings for companies in the S&P 500 index have fallen for five straight quarters, including the current one. The good news is that earnings tracker First Call expects profits to begin to finally grow again in the second quarter.

Now the bad news: Operating earnings per share plunged from their 2000 peak of more than $56 a share to about $39 in 2001, erasing most of the gains of the late 1990s boom.

"We believe earnings momentum should turn strongly positive by the second quarter, but earnings gains in 2002 are unlikely to come close to reversing the collapse in 2001," Merrill Lynch economists Bruce Steinberg and Gerald Cohen said in a recent research note.

The Enron Effect

Current conditions: Stormy

One variable that could change everything is the depth and duration of the current onslaught of embarrassing accounting revelations. Enron got the ball rolling, and new revelations are cropping up all the time, including one Friday from IBM (IBM: down $5.00 to $102.89, Research, Estimates).

Uncertainty has crept into the stock markets, with investors wondering whom to trust and feeling less inclined to make risky bets. Rising credit concerns could also increase the difficulties and costs of corporate borrowing, cutting into profits and leading to more bankruptcies. And consumers, worried about their 401(k) plans, could also be less likely to spend.

Still, most observers expect the Enron storm to blow over without major damage and leave more accurate corporate accounting and reporting in its wake.

"If robins are the first clear sign of spring, then financial crises [like the Enron scandal] are the first clear sign of a recession's end," said Paul McManus, director of fundamental research at Independence Investment.