Business Intelligence Brief: August 8, 2012
Housing Market Rebound Looks More Solid Every Week
Most assessments of the economy make the assumption that no real recovery is possible without a rebound in the housing market. The connection between the sector and the rest of the economy is complex but it is hard to argue with the notion that this underpins consumer health and that progress in the housing sector is dependent on good news in areas like employment and consumer debt. There is a great deal of economic activity surrounding home building and selling and the home is the key measure of wealth for most people. The decision to buy a home is dependent on confidence – belief that one will have the means to make mortgage payments for 30 years. This is what connects the housing sector to the employment rate, wage rate and savings rate. Now that we are clear that what happens in housing doesn’t stay with housing it is important to note that there is finally some good news to react to.
The price of homes has started to rebound – reaching a level of growth in the last quarter that has not been seen since 2004 or 2005 (depending on how one measures it). The data from Freddie Mac and CoreLogic differ somewhat given their different methodologies but they are both pointing in the same direction. The CoreLogic numbers indicate a 6% gain from the first quarter and Freddie Mac notes a 4.8% gain. The annual increase is between 2.5% and 2.8%. These are the first such numbers since the middle of the last decade and suggest that home prices are rising faster than they did in the middle of the housing boom.
The reasons for that hike in price is about as simple as it can get. There are too few homes available for sale given the demand and that is a good place for the sector as a whole. For the past five years the builders have all but stopped construction and now there is evidence that the existing home market is finally drying up. The foreclosures have largely been dealt with and there are relatively few left on the market, even fewer at bargain prices.
Analysis: Assuming that demand holds steady or expands, there are three likely reactions from the sector as a whole. The first and most rapid reaction will be a further hike in the price of homes. In some markets that increase will be substantial but in most markets there will be noticeable hikes. This will likely create an even more aggressive demand as potential homeowners will soon realize that they are unlikely to get any better bargains in the future. The second reaction will flow from the first. The builders will cautiously start to reenter the market with new homes provided there is perceived demand. It is not likely that there will be a lot of speculative home building at first but custom homes will start to make a comeback. The third reaction will be from the owners of existing homes who have been reluctant to bring their house to market in the past due to the low price environment. Now they will begin to see price hikes and that will be enough to get them back in the selling mood. As long as the mortgage rates remain low it is expected that there will be sufficient demand to cope with the higher prices. Housing is not yet robust but at least it has shown some signs of life.
August – Time for Reflection and Review
It is probably the routine of the school year that prompts the flurry of high level meetings and think tank sessions that take place in the month of August. We seem to be used to taking a deep breath in August prior to buying our new pencil box and hitting the books. The Kansas City Fed sponsors the Jackson Hole meeting of the world’s central bankers; the Europeans hold their big end of summer summits (although lately there seems to be a European summit almost every week). The investment firms pull their customers together for big sessions at some of the nation’s tonier resorts. These are all meetings devoted to figuring out what comes next as far as the economy is concerned. Part of the motivation for all these sessions in August is that the last four months of 2012 will be critical to the performance of the economy in 2013 and will provide a gauge of just how challenging 2012 will be.
This is the start of the retail selling season with the four biggest shopping periods in the year coming one on top of the other. Thus far it looks as if the back-to-school sales are decent but not spectacular and it is still a little early to forecast Halloween. The retailers are planning an inventory lean Christmas thus far. The elections are gearing up for the serious run between Labor Day and November and this time there is a lot at stake as far as the economy is concerned. Some of the economic indicators have been pointing in a positive direction (housing, exports and some sectors of manufacturing) but the indicators that most people pay the most attention to are still in the doldrums, most notably unemployment. The sessions that are taking place are all focused on what are perceived as the biggest challenges and they are surprisingly consistent. There is not exactly a consensus view but more agreement than one normally gets.
Analysis: There are six risks that have emerged as the most important although there is considerable difference of opinion as to which of them is the most important. At the top of most lists will be some variation on the theme of uncertainty and political inaction. Most of the debate is over the looming fiscal cliff issue and the conclusions are all the same. This is a Congressionally created disaster and one that could be solved in an afternoon should the powers that be find a way to focus on something other than their political careers. The consumer is most concerned with the tax cuts while the business community is most worried about the cascade impact of the budget cuts. This is the most uncertain situation but there are many others as the business community struggles to understand the rules of the game as far as banking, health care, regulation and so on.
The second most commonly cited risk to an economic rebound is related to Europe. The major fear is that nobody seems to be in charge and there is no sense that the Eurozone leaders have a plan. This is related to the frustration with the domestic leadership. If the policy makers can’t agree on a policy it is nearly impossible for the private sector to develop a strategy. There is the same sense about Europe as there is regarding the fiscal cliff. If the Europeans would focus on the immediate issue and execute a rescue of the troubled economies all would be well. That is more than a little naïve and tends to dismiss the complexity of a euro rescue but there is certainly evidence of significant gamesmanship that is slowing progress towards a reasonable bailout.
The third area of risk is a little less urgent and much less political but most assert that this will be a far longer lasting threat. The last four years has featured significant consumer deleveraging and much has been written about the frugality that is suddenly in vogue. Some have commended this new found commitment to living within one’s means while other desperately wait for the consumer to come back to life so that an economy based on consumer activity can roar back to life. Critics have pointed out that there has not been all that much voluntary deleveraging as most of the progress in the statistics comes from foreclosures, bankruptcies and other involuntary acts of deleveraging. There is a noticeable reduction in credit card debt but non-revolving loans are still growing. There is disagreement over whether the consumer is still planning on more debt reduction or if the deleveraging has really never been a conscious choice.
The fourth risk comes from the global nature of the economic crisis and this is something that has been discussed for the past four or five years. The US is in a stunted recovery while Europe has fallen back into recession. China is slowing, India is struggling and Brazil is hemmed in by nascent inflation and a slower pace of growth. In previous recessionary periods there has always been a region of the world or nation that could pull the rest of the economies back towards prosperity but this time there is near universal struggle and nobody seems to have the ability to pull more than their own weight – if they can even do that much. At one point it looked like China was ready to step up but now they have seen their rate of growth fall by almost 4 percentage points. The only real success that the US economy has had has been in the export sector but if the Chinese and the other emerging markets are slowing there is not much for the US to export.
The fifth risk that has been cited by more than a few think tanks and conferences is the threat of the demographic imbalance. For most of the last fifty years the economy has reacted to the demands of the Baby Boom generation. This was the cohort that drove the consumer sector and most every economic surge of the last half century. Now that generation is making its final statement. As Boomers go into retirement it is clear that too many of them are not ready. The recession took a chunk out of what had been set aside for retirement and that has compounded the problem of inadequate planning. There are not enough people coming from the next generation to handle the burden of the Boomers. Those who expected to sell their homes and investment are finding a cash strapped next generation that will not be able to play their role. There will be many who need to stay in the workforce but nobody knows quite how that will be handed and looming in the not distant future is the specter of a Social Security system that can’t handle the strain.
Risk number six is not on everybody’s list but it makes the cut for some of the investment centered organizations. There have been those who have been warning about inflation for several years now but thus far nothing has materialized. This is not to say that the threat has vanished but most of the factors that would seem to presage inflation have not played out as expected. This has some positing that deflation may be a bigger threat – at least in the short term. There are several factors that are pushing deflation as an issue – the write down of European debt, the write-downs of US consumer debt, the aging population discussed above and the near constant devaluation of the major currencies. All of these point to deflation as a bigger threat right now than inflation.
Hiring Not Evenly Distributed in the US
The job market is not especially healthy in the US as a whole – that much has been pretty obvious as the rate of unemployment has remained stubbornly above 8% for the year. When one examines the distribution of hiring there are obvious differences between various regions in the US. The growth is almost entirely in the Midwest and South where the hiring rate is up by 38% and there are three applicants for every job posted. In the West there are 4.3 job seekers for every posting and the numbers are nearly as bad in the Northeast. The opportunities are not evenly distributed.
Analysis: Some of the disparity is related to the fact that the Midwest and South experienced a more severe reaction to the recession and they have thus experienced a little bigger rebound but there are other factors at work. The manufacturing revival has affected these parts of the country more than the coasts and there has been a more significant decline in the service sector economy in the coastal states as well.
British Economic Predictions Weaken
The Bank of England has issued its latest assessment of the UK economy and it is more depressing than ever. They are not the only ones to assert that things are going to get worse in Britain before they get better; their report is just the latest in a long line of gloomy assessments. Just three months ago the BoE had predicted that the economy would be growing at around 2.7% in the next couple of years – not far from the 3% that is generally seen as minimal if there is to be progress on employment and overall industrial expansion. At the time of that assessment it did not look as if the crisis in Europe was going to have such a profound impact and there was some confidence that British manufacturing would emulate the success of the sector in Germany and the US. Those assumptions are now in question. The new data from the Bank indicates that the economy will be growing at no more than 2% in the next two years and that is far below the level needed to make progress on jobs or industrial output.
The reasons for the deteriorating growth prospects are varied and the BoE report has tried to navigate the delicate political situation. The critics of the Cameron/Osborne austerity effort have laid the blame for British economic malaise squarely on the back of the austerity program and assert that a shift in commitment to budget cuts would do wonders for the economy of the UK. The report acknowledges that austerity has had an impact as there have been thousands of layoffs and many businesses that have lost income as their contracts with the government have been reduced or eliminated. The report does not assert that this is the critical issue however.
The Bank of England has trotted out the uncertainty concern as well and they point to the crisis in the Eurozone as the most uncertain situation of them all. The assertion three months ago was that Britain was not all that connected to what has been happening in Europe as the British banks do not have the exposure to the troubled economies of Greece, Spain and Italy that many of the European banks do. The sense was that Britain could survive the chaos in Europe with a focus on other markets and opportunities – something akin to what the Germans have been able to do. It turns out that this was an overly optimistic assumption. The British have not been as successful at diversification and they have thus been hampered by the fact that demand has steadily dropped for industrial output. The US remains a major trade partner and the sluggish pace of recovery in the US has affected British exports. The decline in demand from Europe has been profound and the strength of the pound against the euro has been no help.
Analysis: If the Bank’s assessment is this miserable there are expectations as far as next steps. It is now assumed that there will be another major round of stimulus activity and that means bond buying. The interest rate tool has been employed to the extent it can be and that leaves the BoE in much the same position as the US Fed. There is not much left in the arsenal other than trying to impact the long term bond market but that is an indirect approach at best. Just as in the US there is fear that the BoE will make a move and there will be limited response. The markets would likely panic as they perceive Mervyn King as without further options. That would leave all the stimulation to the Cameron government and thus far there has been no signal that it plans to turn away from an austerity effort in any significant way.
Rising Oil Prices
Thus far this year the oil markets have been in a contrary mood. The times when the price traditionally starts to increase have seen price decline and the time that normally see prices drop are now seeing hikes. Much of conventional wisdom has been thrown out. The reduction in price this summer was mostly a reaction to reduced demand and the fact that prices had escalated in the spring due to the geopolitical worries over Iran. The summer driving season was not as limited as expected but it wasn’t really enough to hike costs. Now the per barrel price is hitting a three month high and the price at the pump has jumped by between five and fifteen cents (depending on where one is). The motivation for that price hike is once again geopolitical in nature and only tangentially related to the issues of supply and demand. The reductions in output from non-OPEC and OPEC alike have been limited and demand remains relatively weak.
Analysis: The situation in Syria is worrying the oil markets and for two reasons. The assumption earlier in the year was that the regime of Bashar al-Assad would be able to regain control soon. The perception was that the rebels would soon run out of support and would fade while the regime supporters held on. Now it is virtually certain that Syria is in a civil war that could last for years. Such a conflict will inevitably drag the rest of the region in to the conflict in one way or the other. Iran is already playing a supportive role and there is evidence that Iran is sponsoring Hezbollah as supporters of the Syrian militia. The oil markets are now concerned that oil production will be affected in some way and that makes them nervous. It is not likely that there will be major oil spikes but a steady creep north is already taking place and is going to continue.
The Next Five Trends Appear in the Next Edition of the AEIB
The first five political trends appeared in the last issue of the AEIB and the next five will appear later this week. The primary contests are now over and the real contests are clear. The political pundit column will be back this week and will catch you up on those key Senate races. Check this on our website – www.armada-intel.com If you have not taken advantage of our trial offer on the Executive Brief we invite you to sign up for some free issues by contacting firstname.lastname@example.org. The Executive Intelligence Brief is the companion publication to the Business Intelligence Brief. It is part of the Armada Strategic Intelligence System and is more detailed than the BIB. It is our subscription based publication and is available to BIB readers at a discount.
More Interesting Questions
The very best part about giving presentations (aside from the pure joy of airline travel) is the opportunity to learn what is on the minds of the audience. This is why the question and answer part is my favorite. In St. Louis the questions were related to the relevance of all this data and conversation – what is one supposed to do with this? In Kansas City the theme reappeared and I am starting to see a trend. The average person attending an economics talk is either someone with way too much time on their hands or they are people that are trying to make informed decisions about their business. I hope there are more of the latter and given the question of late I think there are.
The mood is one of frustration and impatience to some significant degree. For almost five years the economy has been in some kind of malaise – some months better and some worse. There is no sense that there is a path out of the mire and that seems to be causing some serious rethinking. Is there a way back to the days of yore, a time of boundless enthusiasm and the promise of prosperity? Is that the wrong question now? Should we be thinking of a new reality that is less than what we had in the past and how should we react to diminished expectations? The feeling is that people want to make a choice and want some kind of signal as far as what to expect. The uncertainty issue that we all harp on these days is manifested in a sense of lost control. For years we felt that we could plan for the future and most of our decisions were based on that assumption. We chose our educational path based on the future, did our jobs with an eye on promotions and raises and we planned for our retirement. Now these techniques are not working as reliably as before and that calls much of our planning effort into question.