Recovery Going Half-Steam Ahead
A blue-chip array of economists spoke at the Metals Service Center Institute’s (MSCI) 2010 Economic Summit, held September 20-21 in suburban Chicago. Good news is that all of them agreed recovery is underway, 2011 will be better than 2010, and we can pretty much put away worries about a double-dip recession and/or deflation.
Bad news is that recovery will be a slow crawl through a mud pile of sluggish housing, stingy credit and lingering high unemployment. The latter is the main culprit restraining economic growth, virtually all of them contend. People without jobs or worried about losing theirs are not inclined to spend money on big-ticket goods such as autos or, especially, homes.
The most optimistic forecaster expected the unemployment rate to drop from 9.6% at the time of the MSCI Summit to 7.5% entering 2012 – still well above the 5% or so considered to be normal in a healthy economy. Most others predicted unemployment to linger at 8.5% or above through the end of next year.
Here are capsule summaries of the presentations of key speakers at the MSCI Economic Summit.
JAMES SWEENEY, Director, Global Strategy Team, Credit SuisseSweeney’s bailiwick was the global economy, and his was a relatively upbeat assessment focused on global industrial production, whose recovery is underway “not to ridiculous levels, but upward.” He noted that “China will be re-accelerating in coming months,” but that U.S. industrial volume and capacity utilization is likely to continue to be restrained. “The big question is on the demand side.”
Demand for industrial goods is a question mark owing to tightened credit, a problem addressed by all the economists gathered at the event. Sweeney offered that “the housing bubble is a global phenomenon,” with prices falling around the world and mortgage lending squeezed. He deemed the so-called “de-leveraging” of the American consumer “an illusion” owing mainly to the disappearance of sub-prime mortgages. Housing recovery will be stymied by an excess of inventory – 19 million empty homes in 2009, compared with 14 million in 2003.
PAUL KASRIEL, Senior VP & Chief Economist, The Northern Trust Co.Kasriel’s 2008 economic forecast was cited by the Wall Street Journal as one of the top five in an annual survey of economists, and in 2009 he was credited by WSJ as one of the few who identified the housing bubble forming early on and the ensuing financial market havoc when the bubble burst. This reporter found his to be the most engrossing presentation.
According to Kasriel, by the time the bubble burst, easy credit and home equity loans led to Americans spending more than they earned for the first time since after World War II, when our nation was transitioning from a wartime to civilian economy. “Borrowing against housing fueled (recent) spending,” he said. “It was the dominant debt in our economy.” He deemed the current “de-leveraging” phenomenon to be involuntary – i.e., people want to borrow money, most just don’t qualify anymore.
The subsequent contraction of bank credit is at the root of our economy’s present woes, Kasriel contended. The Federal Reserve has done just about everything it can to reinvigorate bank lending, cutting the federal funds rate to almost nothing (0.25%), but with little to show for it. “Fiscal stimulus without bank credit growth won’t accomplish much,” he asserted. “China’s government also provided stimulus to its economy, but it accomplished a lot because it was accompanied by an explosion of bank credit.”
Why are banks sitting on some $1 trillion in cash? “The banking system is concerned about capitalization,” he said. “They are adequately capitalized today, but may not be two years from now when they are bracing for a second wave of defaults from commercial mortgages.”
On the positive side, Kasriel noted that July and August saw the first increase in bank lending in 29 months. He predicted that trend to continue and banks to return to their prior peak in lending volume by the first quarter of 2011.
When asked during a Q & A session when companies will start hiring again, Kasriel responded that “the economy must grow consistently at 3% or more, and I think it will if the bank credit trend continues.”
DAVE HUETHER, Chief Economist, National Association of ManufacturersFocusing on the manufacturing sector, Huether began with the positive assertion that “U.S. manufacturing is not going away.” He noted that although the 11.7 million manufacturing workers are about equal to what the sector employed in 1948, U.S. industrial output has grown some 500% in that time span. Our share of global output is about 20%, far surpassing that of our closest rival, China, at 12.8%.
The Great Recession dropped U.S. manufacturing output 17.5% between June 2007 and June 2010, according to Huether, but that sector is rebounding faster than the overall economy, thanks largely to a spurt in exports. However, like all other businesses, manufacturing’s recovery will be restrained by consumer demand held down by high unemployment. In that regard, Huether was the most optimistic of the economist speakers, predicting unemployment to decline to 7.5% going into 2012.
He believed manufacturing was due for a 1-2% contraction in the last half of 2010, but “probably will accelerate in 2011,” due largely to his relatively rosy view of the unemployment picture.
WILLIAM STRAUSS, Senior Economist & Economic Advisor, Federal Reserve Bank of ChicagoStrauss disagreed with Kasriel’s contention that today’s de-leveraging is involuntary. He thinks consumers will be reoriented toward savings over spending for some time to come. “In the long term, this is good for the economy,” he said, “but it takes time.” Strauss predicted modest economic growth of 2.4% in 2010 and 2.9% in 2011.
“The recovery will be modest compared with previous recoveries where 5% growth rates were typical for the two years following a recession,” he stated. “That’s because of the struggle of consumers to really go out and spend.”
He predicted “solid growth for manufacturing in 2010-2011 due to improving demand and rebuilding depleted inventories.”
KEN SIMONSON, Chief Economist, Associated General Contractors of AmericaSimonson is one of the construction industry’s foremost economists, and his data-oriented presentation revealed not many surprises. Single-family housing remains sluggish and will be so for the foreseeable future, though the biggest problems are with multi-family housing and most other commercial sectors. “In general, developer-financed categories have been disastrous,” Simonson said, due to difficulty in securing loans for various projects.
To illustrate he pointed to 12-month declines (July 2009-July 2010) in spending of -24% for retail buildings, -38% for warehouses, -40% for office buildings and -56% for the hotel/motel category. “I think we’ll see recovery soon, though mostly for renovations rather than new construction,” he stated. Simonson reasoned that businesses will not be looking to expand commercial facilities until they begin hiring in a big way, which as all the economists contended, will be slow to come.
He foresaw upward trends for spending on education facilities and hospitals, although school building is likely to be constrained at the lower grade levels by lower municipal tax revenues due to home price declines. His forecast for 2011 was for residential spending to grow between 5-10% and nonresidential to bottom out and start to eke out modest gains.
Simonson pegged total construction spending to grow between 3-7% next year. “I think stimulus money will make a difference in some categories and help moderate the downturn significantly,” he said, adding: “Recovery in housing hinges on the unemployment picture,” he stated. “Things should improve.”
One part of Simonson’s presentation ought to be of particular concern to distributors. He took note of sharp increases in many construction material costs, yet at the same time many winning bids of AGC members have been 10-15% “below the pack.”
“Contractors are paying more, but not getting paid more,” he said. “They’ve been cutting costs and laying off people throughout the recession, but they’re running out of their bag of tricks. This is a recipe for going out of business, and we’ll see a lot more of that.”
PATRICK NEWPORT, Director, Long-Term Forecast, U.S. Macroeconomics Group, IHS Global InsightThe housing market is Newport’s specialty, and he began with a long-long-term perspective, citing data that showed, when adjusted for inflation, housing prices have risen merely about 1% a year for the last 100 years. He also cited an academic theory holding that “real estate bubbles are ingrained in human consciousness, and occur every other generation.” If that’s the case, we ought to be okay for the next 25 years!
Back to the present, he noted like everyone else that “recovery in housing depends on the unemployment picture.” Although past its peak, Newport thinks unemployment will stay above 8.0% all the way until 2014.
Newport explained that unemployment has retarded growth of household formations, a key driver of new home building. From 2001-2007 the U.S. averaged around 1.3 million new households a year. When added to the need for replenishment of homes destroyed and demand for second or third homes, it creates a normal demand for new housing of between 1.5 million to 1.7 million units per year. However, this recession drove new household formations all the way down to 360,000 between March 2009-March 2010 – the lowest since 1947, according to Newport.
“It now takes an average of 14 months for builders to sell their homes, compared to about five months in normal times. It’s been a brutal market for builders,” he said. “Even though builders have stopped building, we have the biggest housing glut ever because due to the recession and unemployment, people are moving back with their parents, divorce is down, immigration is down and homelessness is up,” Newport explained. He expressed concern that about 25% of home mortgages are “underwater” (owners owe more than their homes are worth), which could give rise to a surge in strategic defaults.
“This is something we haven’t seen before but will see if there’s a back-to-back recession. It’s a big problem for the banking system,” Newport said.
On the bright side, he expressed belief that “the inventory overhang has peaked” and housing will turn around, though slowly. Positive signals include the fact that housing affordability is at an all-time high (as measured by an index taking into account home prices and mortgage rates in relation to income), foreclosures may have peaked, and bank credit seems to be loosening. “(Lack of) credit is a big drag on GDP in the third quarter, but will be a plus in 2011-2012,” he predicted.
For what it’s worth, conversations this reporter had with various Midwestern steel manufacturers and distributors at the MSCI conference revealed a robust upsurge in business during the spring and summer of 2010. They’re still not back to where they were pre-recession but have started to gain back big chunks of ground.