Kicking the can

The fiscal cliff has been delayed for two months. Fears about how the government would handle the fiscal cliff — the tax hikes and budget cuts that were set to start on January 1st — frightened businesses into delaying capital spending and hiring, diminishing what little momentum the economy had going into 2013.

At the eleventh hour, Congress managed to pass a compromise bill. They extended the Bush tax cuts on all earners making less than $400,000, raised capital gains and estate taxes, extended unemployment benefits, ended the payroll tax holiday, and delayed the sequestration (deep cuts to military and domestic spending) for another two months. The next fight will be over raising the debt ceiling again to avoid the sequestration.

Businesses have reacted to this continued uncertainty by putting off key decisions on investment and hiring. Orders for nondefense capital goods excluding aircraft have tumbled over the past few months and are currently more than 7 percent below year-ago levels. Moreover, new orders are trending below shipments, which in the past has been a warning of recession. Hiring has not pulled back anywhere near as much, however, but hours worked have leveled off. A whole host of businesses have also announced plans to alter their employment strategy now that the new healthcare law is an absolute certainty. Even with these changes, we should expect nonfarm payrolls to rise roughly in line with their gains of this past year and look for the national unemployment rate to remain in line with the current rate through 2013.

Small businesses (which are responsible for about 50% of the national nonfarm, private sector GDP) remain unusually cautious. The Wells Fargo Small Business Index tumbled 28 points during the fourth quarter, which was the largest drop in four years. The quarterly survey, which was taken shortly after the presidential election, was led lower primarily by increased concerns about future conditions. Fewer businesses see revenue growing over the next twelve months, while more see them declining. Businesses are also concerned that they have less ability to control expenses, which has led to even more caution about investment and hiring decisions. For the eighteenth consecutive quarter, more businesses plan to reduce capital expenditures than increase them.

National GDP is expected to slow to an annualized growth rate of just 1.8% in the current quarter, according to The Wall Street Journal’s November forecasting survey, but then accelerate through 2013. By this time next year, the economy should be growing at a 2.7% rate, or about what it did in the third quarter just past. For the full year, however, GDP is expected to expand just 2.4%. That’s far enough above stall speed to keep recession worries at bay — but not nearly fast enough to make a dent in perniciously high unemployment.

That said, there are three economic positives going into 2013: employment, debt, and housing – three things that have been lacking for the past five years.

Jobs are coming back. Hiring is hardly robust, but the national unemployment rate is well down from its 10% peak. By this time next year, the economy should be adding 173,000 jobs a month, up from this year’s 157,000, according to the National Association for Business Economics.

Job growth here in Texas has re-bounded since the end of the recession and the state is expected to see even more growth next year. The Dallas Fed predicts statewide job growth of 2 percent to 3 percent in 2013, down slightly from this year’s estimated 3.2 percent growth, but up from 2011’s job growth of nearly 2 percent. Dallas Fed president Richard Fisher sent out the employment forecast — as well as outlooks on other state economic trends — after “a thorough briefing of the Texas economy” by his staff. Energy, exports, and construction have driven Texas employment above its pre-recession level this year, but growth has slowed since June as energy and export activity have declined.

Still most states and metros would be happy to have 2 to 3 percent job growth. How quickly we see a shift in economic uncertainty depends in part on how soon the fog over taxes and budget cuts lifts. Businesses are in a holding pattern, but they’re in far better financial shape than since the credit crisis.

Where will these jobs be? Low mortgage rates and tight inventories have boosted construction and related jobs. Texas leads the nation in construction job growth, adding 46,900 jobs in the 12 months through October, according to the Bureau of Labor Statistics. Last month, existing home sales were up 29 percent from a year earlier and the inventory of existing homes for sale fell to a five-month supply — the lowest level since February 2007, according to Texas A&M University’s Real Estate Center.

The Dallas Fed expects housing growth to continue at a strong pace next year. While industrial, office and infrastructure construction has been somewhat subdued this year, it recently picked up. In addition, a recent decline in office vacancies in Texas, particularly in Austin and Houston, suggests a gradual improvement in office construction could start in the next 12 months, according to the Dallas Fed.

Compared to the national unemployment rate of 7.8%, Austin’s 5.5% unemployment, San Antonio’s 5.6%, Houston’s 5.8%, and D/FW’s 6.4% lead the nation’s metros on low unemployment. Midland led the state with 3% unemployment. Below is how most of the cities in Texas fared through November of 2012. Most are the envy of the rest of the country.

While Midland had the state’s lowest unemployment, the highest was in Brownsville-Harlingen with 9.7 percent. 2013 should show continued improvement in these numbers.

The preliminary local jobless rates for November were:

The national unemployment rate is still elevated at 7.8% as of December 2012. For the last two years, we’ve been too pessimistic on the unemployment rate because most analysts were expecting some minor bounce back in the participation rate. Instead, the participation rate of the unemployment surveys have continued to decline. Maybe 2013 will be the year the participation rate increases a little, or at least stabilizes.

The recent recession was unusual in its depth and its duration. National labor market conditions have remained difficult for a long time. As a result, large numbers of discouraged workers stopped looking for jobs. A big unknown is whether these workers will stay out of the labor force permanently or enter as the economy recovers. If these workers join the labor force, increasing participation could have a major impact on the unemployment rate in the coming years.

As a result, the unemployment rate likely will stay uncomfortably elevated in 2013. Indeed, by this time next year, the unemployment rate is forecast at 7.5%, or just 0.2 percentage points below November’s reading. The economy is predicted to add 1.9 million jobs during the next 12 months — essentially just enough new jobs to keep up with population growth.

Nationally, with the current uncertainty, the national unemployment ‘headline’ (BLS – U3) will be hard pressed to be under 7%. Here in Texas, the continued strength of energy as well as the West Coast port labor problems should allow Texas to creep under a 6% average for the year. It continues to be a blessing to live and work in Texas.

Consumer debt continues to shrink. The balance sheets of American families look fairly healthy as well. Consumers have been working down their levels of installment debt, and that, combined with low borrowing rates for houses and cars, has eased payment burdens significantly. Consumers’ out-of-control debt loads helped spark the recession, but households are rapidly getting their balance sheets back into shape. To put it in perspective, before the recession, consumers went into the recession carrying debt of nearly double the nation’s gross domestic product. That’s down to below 85% now, and on pace to approach 75% by late next year. Consumers were spending more than they made, to put it simply.

Revolving debt, mostly credit cards, has fallen 19% since 2007. Revolving balances dropped at a 6.8% seasonally adjusted annual pace in July, after falling 4.5% in June. Non-revolving debt has risen, mostly because of student loans. The country has started saving again.

If consumer spending doesn’t come back strongly, it might be because incomes are still well below where they were before the recession, and that households lost about $7 trillion of home equity as housing prices plummeted. That could make them keep the brakes on spending for a while longer. On the plus side, low interest rates have pushed the ratio of consumers’ monthly rent and debt payments to their income to the lowest level since 1984. That’s a function of slightly lower debt and much lower rates, all good news.

Finally, housing is coming back. The best news coming out of the economy should be in the housing market. It has taken nearly seven long years since the bubble burst, but housing looks to have definitively stabilized, with more home-price gains ahead. Housing prices should post an annual gain of 3.43% on a national basis, a significant acceleration over 2012′s increase of 3.31. Because of that rebound strength, we here in Texas will continue to reap the benefits of a stronger real estate market through the year.

Nationally, the inventory of homes on the market is down 20% or more from just a year ago. Nationwide, there are 1.8 million houses for sale. At the peak, in the summer of 2007, that figure was more than twice as high. Sales of existing single-family homes, meanwhile, jumped 11% in the twelve months through November. Demand should remain elevated as the Fed keeps buying bonds so mortgage rates stay low. Why is this important? For most families, their home — not stock portfolios — is their biggest asset.

The wealth effect tied to housing can be quite powerful, as evidenced by the number of refinances in the sand states (California, Arizona, Nevada and Florida) from 2000 through 2006, where appreciation was so high sometimes running as high as 45% annual, year after year. That appreciation went away with the recession and lack of speculation in those markets sometimes to the tune of over 60% decrease in value.

That all has changed. Housing inventory is at its lowest level (4.8 months) since September of 2005. This represents 22.5% decrease as compared to the same time last year. Shadow inventory, the inventory of distressed properties coming to market, is also shrinking. This is for a number of reasons:

1. We are clearing more foreclosures and short sales nationally and locally.

2. Fewer families are falling behind in their mortgage payments.

3. Demand remained strong throughout the year. Home sales numbers continued to increase throughout the year suggesting that the country’s belief in homeownership still remains strong. Even the last “Existing Home Sales Report” from the National Association of Realtors revealed that home sales were up 5.9% from the previous month and 14.5% from the same time last year.

4. Prices first stabilized and then increased – nationally as well as locally, perhaps the biggest story of 2012 is that home values turned the corner and headed upward. By the end of the year, home values were up 10.1% compared to the end of 2011. And they shouldn’t slow down. Pricing of any item is determined by supply and demand. The supply of homes ready for is shrinking in all of our Texas Metros. There are only 5,700 for-sale listings in Austin and 3,500 rentals available with over 60,000 people annually moving here, with a population of 1.8 million. Houston has just over 35,000 listings and 94% rental occupancy with close to 100,000 people moving there annually. The same goes for the other major Texas metros – there is not enough supply for the demand.

Even in the areas that are still dealing with high foreclosure rates and short sales, prices have not tumbled dramatically. The increase in demand will absorb much of this inventory.

Because of this, in 2013 we will see the demand for housing continue to surge. The housing market has turned the corner and there is no reason to believe that buyer demand will not maintain momentum throughout 2013. Household formations shot up to boom-time levels in 2012 and are projected to increase at even a faster rate over the next twelve months. A lack of inventory will be more of a challenge to sales increases than will a lack of demand.

5. Fueling that demand is both move-up and move down sellers who are returning in great numbers. Perhaps what many will find as the biggest surprise of 2013 will be the return of the ‘move-up’ and ‘move down’ seller (often baby boomers seeking to downsize). Over the last several years negative equity has prevented many of these sellers from moving up to the house of their dreams. However, with prices recovering, more and more of these sellers will realize that now may be their greatest opportunity to make the move to a lifestyle they always wanted. Between plummeting property values, severe market depression, and falling incomes, the 2008-2009 recession had an enormous impact on the personal finances of middle-aged Americans. Overall, the median net worth for pre-retirement households fell 36%, reaching its lowest level since 1998, which hit those within one to two years of retirement particularly hard. The financial forecast is improving thanks to the gradual recovery of housing prices, but if that 45-64 demographic stays in the job market and maintains their high savings rate in an effort to shore up their personal finances, consumer spending and the subsequent economic growth could help the local markets dramatically.

6. The group under 40, called Generations X and Y, have been delaying household formation since the recession. What happened to all those buyers? Recent studies from the FHA and FNMA show that they believe in homeownership. Contrary to what many have hypothesized over the last few years, young adults (18-35 year olds) are just as committed to homeownership as previous generations. Recent studies have shown that 43% already own a home, 72% see homeownership as part of their personal American Dream, and 93% of those currently renting plan to buy a home

This, along with the increase in household formations mentioned above, makes us believe that 2013 and 2014 will be the year that many of these young adults will jump into homeownership.

All of this is good news: Housing starts surged to an annual rate of 872,000 this year (2012), the highest since the financial crisis. And that’s expected to rise to 900,000 in 2013.

The timing couldn’t be better. Historically, housing has accounted for 5% of GDP. Today it’s half that. If real estate investments jumps by a percentage point or slightly more of GDP next year, the economy could absorb the shock of the national fiscal austerity and hit its expected 2+% growth rate. Not great, but much better than the last 5 years.
And as Texas has shown the last 5 years, we should continue to lead the market in real estate opportunity.