Consumer spending shows signs of slowing.
		By David Kohl, AP

Flush with cash and ready to spend, CEOs are expected to invest heavily in everything from productivity-enhancing equipment to new office buildings and retail space.

Consumers, meanwhile, will likely take a bit of a breather. Higher interest rates, slower home price appreciation and rising energy bills are expected to cause a slowdown — but not a collapse — in consumer spending growth.

The switch means the U.S. economy will be in a healthy position again in 2006, just with a different driver behind the wheel.

"Consumers have hung in there and done better than people expected," Bear Stearns senior economist Conrad DeQuadros says. Going forward, "It's really going to be more about businesses."

For the economy, that's a plus. After being lopsided in its dependence on consumers, the economy will be more balanced between consumers and businesses. That may help the economic expansion, which is now more than 4 years old, last longer.

"The leadership in the economy is going to shift from housing and consumers to businesses," Wachovia economist Mark Vitner says. "There's nothing unusual about that. It's healthy."

Businesses flush with cash

John Cassidy has a big year planned. The owner of commercial printing company Duplicates INK in Conway, S.C., is planning to invest as much as $750,000 this year, up from $100,000 in 2005. He's buying printing presses and mailing equipment as well as a new building to house his expanding business.

"The business has just been going in the right direction," Cassidy says. "In order to continue growing, we need to put the investment in."

In a survey of 117 CEOs of major companies taken Nov. 21-Dec. 8, 56% said they expected to increase business investment in the next six months, according to the Business Roundtable. That's the second-highest percentage in the survey's three-year history and is up from 50% a year ago and 35% in December 2003.

Stanley Bergman, CEO of Henry Schein, a publicly traded medical-supply distributor, expects business spending at his company will go up 20% this year, primarily in technology.

Even manufacturers, who were the hardest hit in the most recent economic slowdown, are getting in the game. Some 43% of manufacturers surveyed by the Institute for Supply Management in December said they planned to increase their investment in 2006. Of those who projected an increase, they expected an average 34.5% gain in spending.

Norbert Ore, head of the ISM manufacturing survey, says many factory owners are investing money to reduce their energy consumption in addition to updating information technology equipment.

Such plans are a significant change from just a few years ago. Stung by a decline in the stock market, corporate ethics scandals and an uncertain business climate following the Sept. 11 attacks and amid the wars in Iraq and Afghanistan, businesses significantly retrenched.

One of the main reasons businesses are boosting spending now is that they are sitting on a tremendous amount of cash. In the third quarter, U.S. companies had a record $1.4 trillion in liquid assets, up 46% from the same period in 2001.

DeQuadros of Bear Stearns says he looks at the gap between what businesses are spending and how much cash they have on hand. As a percentage of U.S. economic activity, the gap is now the highest on record, he says.

Says Wachovia's Vitner, "(Businesses) have so much cash, they have deferred so much upgrades on computer systems and equipment that it's now time to move forward with their investment decisions."

Rising interest rates are expected to not have as much of an impact on businesses as on consumers because many don't need to borrow in order to spend. And even for those who are borrowing, rates are still relatively low.

"Long-term interest rates are still not high by historical standards," says Sempra COO Neal Schmale, whose firm is expected to spend $1.6 billion next year on investment, including on facilities to import natural gas. "Interest rates are not to the point where they would affect our capital spending."

Companies are also enticed to invest because they are getting to the point where they are using more of their available resources. The Federal Reserve said industrial firms were using more than 80% of available capacity in November.

Hank McKinnell, chairman and CEO of Pfizer and chairman of the Business Roundtable, calls 80% a "signal" to companies that it is time to increase available capacity so they can produce more to meet demand.

Consumers slowing down

Unlike businesses, many consumers are slowing down. Take Joseph Frank. The 28-year-old product test technician for Ford bought a new, $40,000 F-150 truck the day after Christmas after receiving a $6,000 cash-back offer in addition to his employee discount. But between the truck payments and mortgage, "Disposable cash is just not going to be there" this year.

So Frank plans fewer trips to the bar with his friends to watch the Detroit Red Wings play and may not take his usual trip to Las Vegas this year.

Consumers like Frank have been the key drivers of the economy through turbulent times in the past few years. Despite the Sept. 11 terrorist attacks, a falling stock market, the war in Iraq and massive hurricanes, consumers have continued to spend. And spend.

That kept the overall economy humming. Although the economy sank into a recession in 2001, it ended up being one of the mildest recessions in U.S. history.

A number of issues are expected to slow — but not stop — consumer spending growth this year. In fact, the slowdown probably already started. Spending during the holiday shopping season at chain stores rose 3.5%, according to the International Council of Shopping Centers, calling the gain "moderate." Retail giant Wal-Mart reported its smallest gain in sales in December in five years.

Behind the slowing:

Housing.

Homeowners have benefited from record home sales and appreciation in recent years. Consumers have supported spending by extracting equity from their homes in the form of large profits when they sell, by refinancing at higher dollar values and cashing out the difference between the value of the old mortgage and the new one or by taking out home-equity loans reflecting their homes' higher values.

But economists expect that with rising interest rates, home sales and price appreciation will slow in 2006. National Association of Home Builders chief economist Dave Seiders predicts home price appreciation will be in the single, rather than double, digits this year. The National Association of Realtors expects sales of previously owned homes will fall 4.4% in 2006 from the previous year.

With fewer sales and slower home price gains, consumers are unlikely to continue to use their homes as piggy banks to fund trips to the mall.

"We expect that the adjustment in housing activity and prices, and the declines in mortgage refinancing in response to rising interest rates, will contribute to the moderation of consumption growth in 2006," Bank of America economists Mickey Levy and Peter Kretzmer said in a note to clients this month.

Energy.

Although some energy prices have retreated from the all-time highs hit in 2005, energy bills are still higher than they were a year ago. For many consumers, that means they have less money to spend in other parts of the economy.

Winter heating costs will hit particularly hard. Homeowners on average will see a 25% increase in heating costs from a year ago, the government projects. That would be the biggest gain in five years.

"That's going to be a shocker," says David Levin, CEO of Casual Male retail group.

The increase in prices has already had an effect on Brent and Barbara Hessel. After recently receiving a nearly $300 natural-gas bill for their three-bedroom, Bethesda, Md., home, the couple, who are expecting their first child in February, have decided to try to cut back on other expenses, such as dining out.

"We're trying to constantly be more aware of what our expenses are," Brent, 27, says.

Cars.

A large portion of the consumer spending gains in the past few years has been in incentive-induced car sales. In 2005, sales at car dealers accounted for about one-fifth of consumer spending, according to data through November, the most recent statistics.

But with interest rates rising, the deals are expected to fade, leading to slower car sales. George Pipas, sales analyst at Ford Motor, expects car sales to be lower this year than in 2006, but says the drop will not be too large.

There are other areas that may see a softening in the rate of spending growth. According to a Federal Reserve report analyzing mortgage refinancing in 2001 and 2002, consumers spent money they received from cash-out refinancings on home-improvement projects, cars, vacations and investments. Also popular was using the money to pay down debt.

Consumers still key players

But the picture is not at all gloom and doom. Consumers are hardly expected to fall off the map.

If anything, consumers have shown in recent years that they like to spend money, no matter what. With rising interest rates, interest-bearing savings accounts and other investments will likely bring greater returns, giving them money to spend.

Plus, many consumers who have tapped equity in their homes in the past few years haven't spent the money yet. Lehman Bros. estimates that half of the $2 trillion in housing equity extracted since 2001 hasn't been spent. This may be the year they pull the trigger.

The overall economy is expected to remain healthy, leading to additional job creation, which will support spending.

"I don't think it's the case that we suddenly turn off the tap, and consumer spending stops dead in its tracks," says Nigel Gault, U.S. research director at economic consulting firm Global Insight. "It's more gradual."

Mark Zandi, chief economist at Moody's Economy.com, says the moderation in the importance of the consumer will likely continue for years. Consumers 45 to 54 years old traditionally spend more than any other age group. The share of the population in that age group is peaking as the baby boomers age. That soon will put them into an age bracket in which consumers typically spend less than others.

"The aging of the large baby boomer cohort has been a powerful tailwind behind consumer spending during the past quarter century, and it is set to become an equally powerful headwind," Zandi says.

Contributing: Del Jones, Sue Kirchhoff and James R. Healey