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Article Excerpt
Commentary
The first haft of 2008 has seen erosion in economic fundamentals. While some argue that the economy still is not in a recession, consumers and businesses and government budgets are all feeling the pressure of a contraction. Indeed, there is little positive news to suggest a near-term turnaround in economic fundamentals. Rather than debate whether there is a recession, attention is more properly focused on how deep the contraction will be and how long it will last.
Many of those who were in the "it-will-be-fine-by-2009" camp have tempered their predictions and are now expecting further erosion in market fundamentals and a delayed recovery. While some are more optimistic, the general consensus among emerging economic signals suggests the economy is in for a difficult period.
Given the financial stress many households are facing, the debates on the economy and what to do about the housing crisis, high and sticky gasoline prices, and the rising costs of food and other essentials are likely to catch the attention of voters. As election campaigns get into full swing, the economy is likely to move to center stage. Debates will occur on the national stage, as well as on many local stages as jurisdictions struggle with declining revenue streams. Unfortunately, there are no easy solutions as the economy continues to wind down.
On the real estate front, the housing market certainly has more problems in front of it as the sector contracts to find the bottom of the inflection point. The commercial real estate market is faring somewhat better, although tightened credit, weakening employment, rising costs, and rekindled interest in risk taking is forcing many on the defensive.
Clearly, the heyday of the housing and commercial market is behind us, with many challenges ahead. The positive news is the commercial market has been able to avoid a major collapse due to the absence of industry-wide overbuilding, voluntary curtailment of new construction, and continued appetite for product-albeit more selective-among institutional investors. However, the commercial sector will not escape the economic downturn unscathed. In particular, market values will face downward pressure as capitalization rates rise to reflect higher risk premiums and a return to longer-term averages. In addition, investors facing refinancing of bullet (balloon) loans and buyers dependent on new financing will face added scrutiny. In addition to tighter underwriting standards, many borrowers will be forced to accept recourse loans, turning back the pages to the times where lenders originated loans for their portfolios rather than for securitized offerings.
The Economic Environment Economic Growth
The pace of gross domestic product (GDP) growth remains disappointing, with limited prospects for a seasonal surge in the second haft of the year. On something of a positive note, a June report showed that manufacturing activity outperformed expectations although the improvement was moderate and just slightly above the expansion threshold.
However, employment figures and other signals are likely to put a dampener on any optimism that might be gleaned from the figures. The fact that the United States shifted to a service economy also reduced the importance of the manufacturing sector as a true leading indicator. Although, when combined with the pattern of leading indicators, the data suggests that the economy may be able to avoid slipping into a major recession.
The near-term outlook for GDP is tempered by a number of factors that suggest the current weakness is likely to continue into next year. Diminishing state coffers due to declines in sales and income taxes are likely to put a dent in state employment figures, creating budget pressures that could curtail additional spending. While exports might provide some upside potential due in part to the cheaper dollar, the global economy is slowing down as well, dampening demand for U.S. exports.
Rising energy costs are affecting many markets across the globe, with little respite in sight as the demand for energy rises on the global front. Similarly, shipping costs are rising and placing upward pressure on import prices, with some additional upside risk if the labor unrest on the docks cannot be resolved. Increasing tensions in the Middle East punctuate the tenuous nature of the global economy and the worldwide dependence on foreign oil.
Employment
Through the first half of 2008, a contraction of employment has been symptomatic of the slowing economy and lack of confidence among business leaders. Declining employment levels are the most significant in the Financial services sector, which is still reeling from the spillover effects of the subprime mortgage market and the expanding credit crisis.
However, other sectors have not been immune to the slowing economy. According to the latest statistics, employment continued to fall in the following sectors: construction, manufacturing, retail trade, and temporary help services. On the positive side of the spectrum, health care, education, and local government employment have avoided some of the downward pressure. However, the latter sector is likely to start feeling the pressure in earnest as the dramatic erosion in the coffers of local government hit home and forced budget cutbacks.
As in other contractions, the softening in employment has been hardest on marginal households who are at the mercy of the economy. The plight is evidenced by the challenges students faced as they struggled to find summer employment. In the second quarter, unemployment rates continued to rise with a significant increase in newly unemployed and an increase in the long-term unemployed.
Given the current economic malaise and lack of any obvious turning points, the job market is expected to remain soft over the near term with further increases in the unemployment rate. Additional layoffs are possible as companies continue in their defensive mode and wait for signs that the bottom has been reached. However, absent a major shock to the system or unexpected occurrences, the softening should be tempered although this outlook will provide little solace to those who have lost their jobs and are struggling to find new positions.
Inflation and Interest Rates
Inflation is taking center stage as a major factor in the erosion of consumer confidence levels. The most obvious of these pressures is at the gas pump, where consumers are likely to see little respite from record prices throughout the summer. Increasing energy costs are not only plaguing U.S. consumers but also causing concerns that spread from Western Europe to Southeast Asia.
Another inflationary area that is creating more angst among consumers is a dramatic increase in food prices due to a confluence of events ranging from flooded farmland in the Midwest to drought conditions in much of the South. At the same time, costs of medical care continue their upward spiral. Commodity prices are also on the upswing, with prices close to record levels. This upward pressure is particularly strong on dollar-denominated commodities. These conditions are expected to continue creating upside risk for inflation.
The inflationary forces on the domestic front are affecting the global economy, leading to a call to increase loan rates to thwart inflation. The price of oil is likely to remain a major wild card, with efforts to moderate energy demand in the United States expected to have limited impact over the near term. Rising global demand for energy is likely to continue to put pressure on prices. The role of speculators in driving up oil prices has provided insights into some of...
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