real estate

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Dreary As She Goes

Today’s news matches the weather: dreary, below average, and dispiriting. This is supposed to be spring. It feels very far from that.

I suppose there is no real news in the report that housing starts gave up what meager ground they had gained in March. April’s drop of 10.6% to an annual rate of 523,000 is simply bad. Most analysts were hoping for a continued bump up, with 575,000 being the most commonly quoted expectation. So much for that. If we look at the three month moving average to eliminate the monthly quirks in the data we find that starts are stuck around 542,000. That’s about half what they were during the more normal and healthier years back in days gone by.

This rather depressing level of activity in housing should be a surprise to no one who pays attention to the longer term, or, dare I say it, to history. Crises precipitated by bank stupidity, as our latest disaster was, are always – always – followed by very long slow recoveries. So long, and so slow, that to many people they don’t feel like a recovery at all.

Couple that historic viewpoint with the more contemporary redistribution upwards of national income, so that the rich receive a larger share of the spoils, and it is no wonder at all that the engine driving us forward sputters and belches fumes rather than hums along. This is not me being unduly pessimistic. It is simply what I read into the data through a historically informed lens. Wall Street and our memory challenged media has far too a superficial view. They are looking for a more speedy recovery. They won’t get it. Not that they understand the impact of income inequality. They are the ones who benefitted, so in their part of the world all is well. Thus they have difficulty internalizing the consequences of the much worse conditions that the rest of the counrty is still wallowing in.

I think it is this bifurcation in experience that is driving the inability of our elites to comprehend what to do. They feel good once more. They question the effort of the rest. They feel frustrated that the general economy is not responding the way their localized economy has.

They have lost touch with the rest. But we knew that already didn’t we?

As in housing, today’s industrial production report was downbeat. Far from more growth, which is what the media was touting as recently as yesterday, production was flat. Worse yet, both the February and March numbers were revised downwards. Clearly things are not as rosy as we had been led to believe by the preliminary figures. Yes, production is up about 5% over the past twelve months, but that is not exactly a boom. And capacity utilization actually fell slightly in April, and now sits at 76.9%, which is way short of a level at which inflation could be expected to kick in.

Amongst the big reasons for this rather dismal report is the flow of auto parts from Japan. The recent disaster there is reducing the availability of parts for US producers and is thus slowing activity : auto production fell from an annual rate of 9 million units to 7.9 million units in April. As long as the Japanese supply bottleneck persist I expect production to bump up and down rather than develop along a consistent upward trend.

So, what do we make of this?

Obviously the economy is not in ruddy health. It is not contracting either. It is simply chugging along, and remains very prone to downside risks. I just cannot see housing building ahead of steam any time in the next year or two. The aftermath of the bubble has wreaked havoc with the backlog of unsold homes, rotten wage increases, and household retrenchment draining away demand or skewing supply. Prices are soft and will stay that way. Indeed the longer the market stays weak the more likely we will see another jolt down as the backlog of people wanting or needing to sell outstrips the recovery of demand. Add in the stupidity of the banks and their total volte face in credit standards – their perennial overreaction is a laughable indictment of any semblance of stability they may lay claim to – and the conditions in real estate remain extraordinarily weak.

As for production: the latest reversal breaks a string of gains and may signal the end of the first phase of recovery. That Japan effect, though, may be adding too much noise to the data, so we must wait and see whether April’s weakness continues. If it does, then I fear that we have reached a plateau of activity far below that we need to lift ourselves back onto a healthy growth path.

Numbers like these are hardly a terrific backdrop against which a debate over the long term deficit and debt issues can be conducted. Any attack on those issues will reduce growth by sucking out demand. Right now we have only a slight latitude for such a reduction. Not that the debate seems informed by facts. As I mentioned above, our elite is indifferent to inconvenient facts. Besides they’re all doing well. For them the recovery has been a good one.

They need to get out more.

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The Economy Slows Down

As we all thought, our economic growth slowed dramatically in the first quarter this year. The headline figure you will be reading about is 1.8% growth, down from the fourth quarter of last year when growth was 3.1%. What you will not be reading is the sneaky rounding up involved to get us to that 1.8%! To two decimal places growth was 1.75%. So being more accurate makes things appear a little worse. No big deal, but indicative of the efforts going in to make the headline look as good as possible.

Here’s the breakdown by major category:

  • Consumption 4Q 2010 .. +2.79%
  • Consumption 1Q 2011 .. +1.91%
  • Private Investment 4Q 2010 .. -2.61%
  • Private Investment 1Q 2011 .. +1.01%
  • Net Trade 4Q 2010 .. +3.27%
  • Net Trade 1Q 2011 .. -0.08%
  • Government Spending 4Q 2010 -0.34%
  • Government Spending 1Q 2011 -1.09%

These figures are what is called the “advanced” report and so will be subject to quite a bit of revision. Even so, it seems that the economy cooled off which could be cause for concern. Or perhaps not as long as the declines can be explained away as oddities unlikely to be repeated. The problem I have with these explanations based on “quirks” is that the economy is replete with such things. There are usually one or two odd numbers that appear to have “one-off” explanations. So there is always an element of forth masking the underlying trend. This is why forecasting the economy is more divination than science – despite all the high paid analysts in the media and at the investment banks.

With that in mind, let’s look at the data.

Obviously the key is personal consumption. It amounts to such a large percentage of the whole that any shift there can make the entire economy move. As you can see consumption faded strongly in the first quarter. One reason could be that bad weather kept people away from stores and that the decline will be offset this quarter as better weather sets in. Frankly there isn’t a great deal of more recent evidence to support that view. Retail sales have been decent, but not great at all. A different view is simply that households have pulled back a bit because unemployment has not improved significantly, home prices are still falling, wages are flat, and debts still need paying off. The accumulation of these factors outweighed the need to spend. hence the decline. I think we will experience this kind of stop-start activity for as long as consumer confidence is depressed. Even though April’s confidence figures showed a slight jump up, they are still not suggestive of strong spending.

The big shift from negative to positive in private investment could be interpreted as businesses preparing for expansion. That would be wrong. Recent durable goods numbers do suggest such a trend. But the first quarter investment turnaround was driven entirely by inventories. Other forms of investment hardly moved at all. As I have said before inventory accumulation is a highly ambiguous number. Sometimes a run up in stocks of goods is a sign that retailers expect high sales and thus are gearing up. Other times an accumulation represents a rise in unsold goods because consumption has fallen away and retailers are stuck with an excess. Which is it now? Looking at the hints I find it hard to tell. A rise in imports along with a rise in inventories is usually a sign that retailers are getting ready for higher sales. That’s a positive sign. I think we should take this first quarter accumulation in this light since it offsets the overly large run down in inventories at the end of last year.

Unfortunately the more telling aspect of the investment numbers are much the same as they have been for a while: weak business investment, and very weak residential investment. Businesses are showing some signs of adding to their capital stocks, but as long as the economy has as much excess capacity as it does, there is no real need to add rapidly. And, of course, we all know that real estate is in the doldrums and likely to stay there.

Trade, too, showed a big shift. The sudden drop in contribution to GDP from trade was driven entirely by an equally large change in imports. This was expected because the fourth quarter saw some very strange and large declines in imports that were not sustainable. All that occurred in the first quarter was that we resumed a more normal level of activity. The bad news was that exports faded a little also, so the resumption of a more normal pattern of imports was not offset by stronger exports.

Lastly, government spending is trending down. This may shock the “big government” hawks, but the numbers don’t lie. Federal spending dropped 0.68%, mostly on the back of a decline in defense spending. This is a notoriously volatile figure depending on bulk purchases. So I don’t think it is indicative of a trend. More importantly, both Federal and State spending on small ticket items and wages is falling steadily. This is the trend to watch. Especially as the deficit debate heats up. We have gone from a point where government spending was acting as a stimulus, to where it now acting as a drag. Presumably this is what the austerity hawks want. It is inevitable that, if government spending is cut, it will act to shrink the economy. We can use the UK as an example. There is an austerity program already in effect in the UK and its negative impact has slowed their economy to a crawl. They are perilously close to recession. Given the relative weakness of our private sector, any strong move to cut government spending runs the risk of doing the same here.

This is all tedious to recite.

What should we make of it all?

The economy is evidently not so strong that it can withstand a bout of bad weather. If that is the key explanation being offered to explain the first quarter decline, then we are not in great shape. This seems to be a very slow recovery, and one that is still very susceptible to downside risks. I suppose there is no news in this, but it should give us all pause to reconsider the current mania for deficit cutting and inflation fears.

Neither the deficit nor inflation should be of great concern right now. The focus should be on unemployment and the huge slack in the economy that such unemployment implies. We have too large a pool of idle workers. That means we are radically underperforming in terms of wealth generation. We are leaving money on the table month after month. This affects us all, not just the unemployed. It would be sensible for us all to be involved in getting those people back to work. That means more support, through both continued easy monetary policy and deficit spending fiscal policy.

This won’t happen, of course, because the powers that be have moved on to combat their imaginary demons of inflation and deficits.

This is looking more and more like the 1930’s.

That didn’t work out too well.

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Where Are We?

It’s tough to tell exactly how the recovery is going. Since this is a busy week for data reports it behooves us to step back and set the stage.

If you recall, at the end of last year the economy was growing at around 3.0% to 3.5% at annual rates. That was a marked improvement, but not earth shattering in the context of post-war recoveries. The general opinion was that we would pick up speed into the first quarter before settling down into a post-recovery ‘normal’ period of steady growth. I was always a slight dissenter to this view because I put more emphasis on our lingering unemployment problems, the risk still abundant in banking, and the downward weight resulting from the real estate collapse. Plus the fourth quarter had one or two oddities – trade and inventories – that pulled reported growth from its underlying trajectory. So my view was that growth would stick in that 3.0% range and then fall a little as we went through this year.

It looks as if we were all wrong.

The problem with the first quarter, we sill see the initial estimate this week, is that the string of oddities has continued. This time things like the very bad weather have taken their toll, and so we should all expect a much lower growth rate than originally thought. If we use the so-called Blue Chip consensus as our guide, the original commonly accepted growth rate was somewhere near 4.0%. This was based on the idea that the recovery was still accelerating, and had not yet peaked, and that consumer demand was bouncing nicely away from the depths plumbed in the recession.

Now that same consensus is looking for a first quarter of 1.7%, with the dramatic revision due to the weather and the fact that consumers have turned much more pessimistic again.

Apparently, one bad winter, and a sudden spike in oil and food prices, have done the recovery in.

So much for robust.

This, in a roundabout way, supports my view, although I make no claim for prescience. The issue is straightforward: as long as unemployment is high, and as long as home prices are weak, households will not shake off their sense of siege completely. It won’t take much to set them back into a savings mode. Likewise, banks may be reporting solid profits – or at least some of them are – but much of the improvement is coming from changes in loss rates, and trading rather form the basic banking that engages with the real economy. This is why I still think we are in a long haul and slow recovery, rather than in the middle stages of a typical post-war bounce back.

Add in the short term rise in consumer inflation caused by those food and oil price increases, and the mood has changed quickly.

This morning’s data on real estate is illustrative.

Sales of new homes in March climbed well: up 11% from February. On its face this is solid. But February was especially depresses because of that bad weather, so a large share of the rebound is simply the working off of a mild backlog. The average between the two months gives us a better longer term measure of sales, and that is essentially flat. Couple this with the news that builder expectations are still at incredibly low levels, and that the inventory of unsold new homes, at 183,000, is stuck somewhere around its 1967 levels – i.e. at near all time lows – and any image of recovery pales away to be replaced by one of decidedly abnormal and low activity. Certainly nothing in real estate suggests a return to good growth. Right now moderate growth would suffice.

The reason I am belaboring this is that when GDP for the first quarter is announced we will all be trying to divine its import for the rest of the year. I am arguing that it may not be much of a signpost at all. It may be too riddled with quirks. That implies we are better served looking at the more frequently announced numbers to get an idea of the general health of the economy.

And those numbers support a very modest outlook.

So what are the risks or problems that prevent us from moving along at a great clip?

  1. The absolute size of the hole we dug back in 2008/2009. This was one mother of a recession, and it has left immense slack throughout the economy. Until that slack is picked up there is little to no incentive for businesses to invest. This is despite interest rates being at ludicrously low levels. Some analysts argue that the Fed’s loose monetary policy has had no discernible effect on investment and thus is a failure. I disagree. It wasn’t a bust. It wasn’t a roaring success either. It just was. It is tough to critique the Fed when the entire system was so close to crumbling. Let’s all remember: the private sector vanished in very short order. Were it not for the government we would have vanished along with it. Business is rightly cagey when faced with skittish consumers and goods of spare capacity. So we can take robust investment off the table as a driver of near term growth.
  2. Austerity budgets will cause at least short term pain. They probably will cause long term pain as well, but that’s not our issue here. Luckily for us the debate will ramble of for a while, so the impact of less government spending will not be hugely significant this year. But it will be a real and noticeable drag when it does show up.
  3. Unemployment is still way too high. Yes, the trends have improved, but by any standard we are a very long way from a return to normal. The labor markets are very fragile. I expect them to stay this way for many more quarters.
  4. World imbalances will leak over into the US economy. Particularly in the form of a continued run up in some consumer prices. There is an argument to make that the world economy is headed into a period of generally higher prices due to the rapid growth of emerging economies and the stress that puts on supply of raw materials and food. But the recent spike in prices is not necessarily indicative of where that longer term price level will be. Short term supply constraints and like the turmoil in the Middle East, and rotten harvests, are masking the long term trend. I expect prices to settle back down, rather than to escalate wildly out of control. Nonetheless in the near term this spike has illustrated jut how vulnerable consumers are.
  5. That is the lesson we need to absorb. Confidence is fragile. To the extent that we rely on consumption and a return to healthy levels of sustainable demand, we are a long way from cured. This past few months have taught us, vividly, that consumers are acting as if on a knife edge. They are pessimistic one day, then optimistic, and then back in the doldrums. The battering they have taken has numbed them sufficiently that they will take a great deal of persuasion before they declare the recovery complete enough to spend the way they once did.
  6. Banking is not yet safe. Since we didn’t reform the banks to make them less dangerous, we have to assume that they are busily constructing their next disaster. Which we, inevitably, will be expected to pay for. Like all habitual blackmailers, the banks will not reform of their own accord. They need to be forced to behave. We will not achieve long term sustainable growth whilst banks are more interested in gambling than in underwriting loans that support the real economy. This shouldn’t be hard to understand, But apparently it is.
  7. Imbalances within the economy lower its potential trajectory. This is a longer term effect and perhaps out of place here, but I would be remiss for not mentioning that our enormously divided economy, between the haves and the have nots, is in itself acting as a brake on growth. It is my view that when the middle class is deprived of disposable income over long periods it cannot act as the economy’s primary consumption engine. It is no secret that the American economy is now so split with respect to the fruits of productivity, and thus income allocation, that its the middle class is now no longer capable of driving spending with sufficient force to justify investment. This sets in motion a steady spiral downwards. As investment is restricted, so future income growth is impaired. This encourages short term thinking in business in the form of cost cutting and wage freezes in order to maintain profit growth. The net result being a shift in income allocation away from wages towards profits and the steady throttling back of potential growth. If this view is correct, then the very clear bias in favor of profits as opposed to wage growth that has dominated American business for the past three decades will end up reducing long term profit. The greed of shareholders will ultimately be self-defeating as they stifle the middle class and thus the very source of their profit.

This is not an exhaustive list, but one point I want to make quite clear: I don’t think that the Federal deficit or the near term bulge in US debt is a particular problem. Our response maybe. Meanwhile we have left unaddressed many of the more obvious sources of risk, like the ones listed above. So as long as were are exposed to such a list we should expect a bumpy and not very fast growth pattern. There’s just too much out there lurking to derail us, and too little policy focus on a long term strategy to reduce inequality, for us to be upbeat.

So look for a lot of sideways motion.

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Real Estate Ekes Out A Gain

Lost in the torrent of talk about austerity and cost cutting are reports about the actual economy. Today we heard that real estate is sputtering along a little better than before. Sales of existing, rather than new, homes rose slightly in March, up 3.7%. This is a nice bounce up from February’s 8.9% drop, but still leaves activity well below any reasonably healthy level. Still we take what we can in this rough real estate market.

The ongoing issue is that distressed sales still dominate activity, thus making it hard to tell what kind of sustainable recovery is under way. Or, indeed, if there is such a recovery at all. Sales have grown in six of the last eight months, which is obviously positive, but distressed sales have been accounting for as much as 40% of the transactions. This factor has led to continued price declines – prices fell 5.9% over the last twelve months and show no sign of stopping that decline.

Sales growth was well spread geographically with only the West showing a decline. The South led the way with an 8.2% growth rate.

There is also a great unknown hanging over the data: the people who issue this report – the National Association of Realtors – are revising their numbers because they are so out of step with other reports. Rumor has it that the revision might drop activity by as much as 20%. That would be quite a jolt to the baseline, but probably would not eliminate the slight gains we have been seeing over the past few months.

In any case, I think it is very clear that real estate will not be a big factor any time soon in fueling overall economic growth. Households are simply too focused on weathering the recent run up in food and fuel prices, avoiding unemployment, rebuilding battered balance sheets, and simply surviving to set off a renewed boom. My view is that prices will still trend down and that sales will bump about for another few months. It will be years before real estate becomes a reliable asset again. Meanwhile those with cash can pick up good deals. Those without will be hard pressed to get credit. This market is going nowhere just yet.

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What Spring?

It’s a couple of years since Ben Bernanke used the springtime “green shoots” description of the economy. Since then we have had a few good quarters of warming weather, but we never arrived at a fully fledged summer. We seem, to extend the saying, stuck in perpetual springtime.

The reason, I think, is clear. Average folks are not seeing much to cheer about. And since they form the bulk of the consuming population they are not providing the power to generate that burst sufficient to allow us to break out.

A couple of recent statistics get at the heart of the problem.

House prices continue to drop. It is astonishing how long this decline has been going on. Yes, there have been a few false dawns along the way, but the trend remains resolutely downwards. Today’s Case-Shiller index merely confirms the gloomy news. Our housing malaise is a long way from being settled. Eighteen of the twenty cities in the index have seen declines in the last twelve months. The worst affected was Phoenix where the drop was 9.1%, whereas Boston saw the least decline at 0.6%. Only San Diego and Washington DC saw increases. Even then San Diego’s growth was minimal at 0.1%. The 3.1% drop in the overall index in January was worse than the 2.4% drop recorded in last December, and the outlook remains bleak

It is glaringly obvious that our housing problems are here for a while longer, and while they linger the shadow they cast is very long indeed. The real estate market has yet to end its adjustment back to a sustainable price level. The inventory of unsold homes is an illusion since it fails to account for a very large number of homes people would like to sell, but are unwilling to do so at what they consider to be temporarily reduced prices. I am surprised that it is taking so long for sellers to realize that their homes are simply not worth what they would like to receive for them. This imbalance, this inability or unwillingness to grasp reality, is creating a burden in the market that is depressing activity and making matters worse. By elongating the period of adjustment we have allowed the adverse psychology to build to a point where the market clearing price is probably lower than it might have been had sellers been willing, or able, to withstand the earlier price declines. In other words had the original decline been sharp enough, and had people acted to dump homes in order to avoid further losses, we might well have arrived at a position from which the market could recover. Instead we are stuck in a long winded meandering decline that casts a pall over whatever recovery may be going on elsewhere.

This story has become so prolonged that there is no real news in it anymore. Yet is is still important to reflect on. As long as the housing market fades the way it is, households will remain reluctant to spend, and will be forced to save to offset the steady erosion of wealth caused by lost home values. The support of the vaunted wealth effect has become the erosion of an insidious poverty effect. Such is the inevitable way with real estate, an asset we should all view with as much skepticism as any other.

As if to support this thesis immediately, consumer confidence has taken a decided turn for the worse.

The Conference Board reports that its measure of consumer confidence dropped sharply in March, down to 63.4 from February’s 72.0. Prior to this decline the index had shown five months of steady increase, so March’s drop stands out as being a sudden reversal of trend. There is no real surprise in the factors driving the decline: food and gasoline prices have spiked up sharply lately; and wages are not keeping up. Add in the rotten employment market and people are realizing that the economy is just not as healthy as it ought to be. Yes, it has risen from the depths of the crisis, but, no, most of the benefit of that recovery has not flowed into average households. Indeed with disposable incomes under pressure from the spike in prices and with profits rather than wagesscarfing up the gains from the recovery we are building a platform for possible decline in growth from its current rather poor level. Big businesses seem intent on shooting themselves in the foot by hoarding cash and not investing. And our government seems intent on aiding and abetting the decline by cutting government expenditure – which means jobs – before we have accelerated enough to withstand the blow. So our economy is not just leaderless, it is being badly led. The direction is the wrong one, and households are reacting by being more circumspect and pessimistic about their prospects.

In essence our leadership, business, political, and professional, has abandoned the task of encouraging economic growth and has entered a phase of self-destructive policy and strategy decision making. Presumably this is the course of least resistance. For business it is always easier to cut costs that to generate new streams of revenues. It is always simpler to offshore activities to low cost production facilities than it is to innovate domestically. And it is more straightforward to deploy attorneys and accountants to reduce tax burdens than it is to boost gross revenues.

As for the politicians. It is a much easier task to sell austerity and reduction, than it is to explain why we need to run larger deficits. After all voters understand the rhetoric of cutbacks more than the more convoluted argument in favor of spending.

So we are locked into decline. Or rather mediocrity. Voters accept that the economy is not going to provide for them. This acceptance is borne out of thirty years of experience with the stagnation associated with the relaxation of regulation and the massive growth in power of business. We have produced an economy that protects profit well. The cost has been the loss of opportunity and relative wealth of the very households who we now need to carry us along. That their confidence is dented or skittish, and that their belief in our leadership is skeptical to say the least, should come as no surprise. The combination of cynicism, anger, and abandonment embodied in our political discourse is dangerous. These are unhealthy times for democracy. But for capitalists the boom continues.

Good for them.

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