Posted At : August 18, 2009 2:37 PM
Economic Update – We won’t be fooled again
Will the market turn up and stay up from here, bringing joy to the world? Or will it take another nosedive fooling “us” again? Well, don’t let yourself get fooled again because it’s coming. First let me clarify that when I say “we”, I mean the collective we, the general public who was caught with their pants down last fall when the market crashed. Luckily we gave our readers a heads back in February of 2008, well before the crash in our Economic Tsunami: How to prepare for this perfect storm special report (ET Link). This report is as pertinent today as when it was written, so go back and read it again. I now have it in pdf format now to email, so let me know if you need another copy.
The report discussed in depth how the demographic landscape of the United States is rapidly changing: A generational change that happens every 40 years with devastating consequences every other generation or every 80 years. In very simple terms, the country is aging. The biggest segment of the population, the 78 million Baby Boomers, is rapidly passing their peak spending years, turning from net spenders to net savers. For a country to grow, it needs more spenders. That’s what drives an economy. Spending patterns are very predictable. From cradle to grave we know how people spend their money and we know that peak spending occurs at 48 years old. At that point, the kids have left the nest and we spend less on everything from food to gas to housing. 1957 was the largest birth year on record. Add 48 years and you get 2005. What happened in 2005? Housing peaked. What a surprise! 1961 was a close second in births. Add 48 years and what do you get….? You got it, 2009. There is no avoiding this and there are no exceptions. Once a nation turns into a nursing home, growth stalls and reverses. That’s what happened to Japan. That’s what’s happening here. No amount of stimulus can alter this track.
The Macroeconomic picture is no less alarming. The 2 major hindrances continue to the massive deleveraging process and lack of consumer spending. As I have been discussing, the current process of deleveraging is massive, bigger than what economists understand and bigger than the administration wants to admit. When a process like this begins, it takes years to wind down and is devastating. There is an estimated $2 Trillion in cash in our economy and now $50T in assets (already down). That leverage is going to shrink dramatically, removing an enormous amount of money out of the economy. Repaying debt will be attractive to many Americans in future years as they shun spending after their huge losses in stocks throughout this decade and their shocking setbacks in real estate. A number will want to be less leveraged as slower economic growth makes employment less stable and unemployment more likely. Lenders, pressed by regulators, will be pushing individuals to lower their leverage by repaying debt. This massive destruction in assets will keep prices down, regardless of government spending, generating deflation, not inflation.
The consumer spending obstacle is real and it is not going away. The consumer is dead. And with 70% of GDP generated from consumer spending, it doesn’t take a genius to know what’s going to happen. When you add in psychological distress of consumers from their loss of money on investments, the huge number of unemployed and the rising savings rate which was zero and is on its way to 10+% to the natural cycle of aging people who are changing from spending to saving, and you’ve got a dramatically slowing economy. Not until the echo boomers, the next generation that is big enough to make a difference, reaches their peak spending years will the economy have a sustainable growth phase.
The recent consumer spending report occurred in the face of gargantuan fiscal stimulus and leaves wondering how this critical 70% chunk of the economy is going to perform as the cash-flow boost from Uncle Sam’s generosity recedes in the second half of the year. Imagine, government transfers to the household sector exploded at a 33% annual rate, while tax payments imploded at a 33% annual rate and the best we can do is a -1.2% annualized decline in consumer spending in real terms and flat in nominal terms? The government simply cannot keep up this pace of spending. If you remove the massive government spending, consumer spending would have shrunk at a 10% annual rate last quarter! Nonresidential construction action sagged at an 8.9% annual rate and this was on top of a 44.0% detonation in the first quarter. The same goes for equipment & software spending; also down at a 9.0% annual rate and this too followed a 36.0% collapse in the first quarter. Residential construction slumped sharply yet again, this time at a 29.0% annual rate. These are the guts of private sector spending and collectively, they contracted at a 3.3% annual rate — the sixth decline in a row. So while there are many calls out there for the recession’s end, it remains a forecast as opposed to a present-day reality.
Slower spending will only exacerbate commercial real estate’s woes, which aren’t so much the result of overbuilding, as is the case with residential. Rather, the problems are due to aggressive refinancing and pricing in earlier years as well as current slumping demand. As retailers must close stores or fold completely, mall space becomes vacant. Warehouses are empty as consumer retrenchment curtails goods imported from Asia and elsewhere. Excess space and weak busiess and leisure travel is axing hotel room rates and occupancy. Layoffs result in sublease office space competing with landlords for tenants. Furthermore, a great deal of real estate debt must be refinanced soon amidst falling occupancy, rents and sales prices as well as tight credit markets. Estimates are that $155 billion in securitizations are coming due by 2012 and two-thirds won’t qualify for refinancing as prices drop 35% to 45% from their 2007 peaks. Meanwhile, $525 billion of commercial mortgages held by banks and thrifts will come due by 2012. About 50% won’t qualify for refinancing since they exceed 90% of the underlying property value. Lenders prefer loans of no more than 65%. Excess house inventories were built up in the 1996-2005 boom and still number about 1.5 million new and existing houses above normal working levels despite the collapse in housing starts and recent stabilization in sales. Excess inventories are the mortal enemy of prices in any goods-producing industry, especially housing.
Housing: it will take several years before excess house inventories are reduced to levels that no longer depress prices. More importantly, not until the echo boomers begin their buying of starter homes in 2012-2015 will real estate make any meaningful recovery. The boomers are done buying homes, period, and there are just not enough people to absorb all the homes that boomers live in, never mind the ones they speculated on. I first said that in my initial warning to sell real estate in 2006 and in my Economic Tsunami report. The same holds true today. You should sell any real estate that you do not want to hold regardless of price.