Are we there yet?

By David Helscher
Special to the Herald

April 27, 2009 09:41 am

— The summer vacation season is almost upon us.
What comes to mind are long car trips with younger passengers aboard. The tedium of a long trip is relieved by a measurement of the small perverse pleasures of kicking the back of the seat versus the risk of an adverse reaction from the occupant of that seat. Impatience is relieved only by the approach of the ultimate destination.
Analysts have been pouring over recent economic data in hopes of viewing the end or at least a bottom to the current economic downturn. Much debate has focused on whether the rate of acceleration, or with an economic downturn, deceleration is significant in identifying a bottom to the economy. This is known as the “second derivative” and measures the rate of change.
The jury is still out on the direction of the economy but there is a consensus that a change in the rate of decline does not necessarily mean we have bottomed.
There have been some promising tentative signs of a slower rate of real gross domestic product decline in the second quarter of 2009. Consumer confidence has improved somewhat. Homebuilders have reported better sales indications and regional business conditions, as reported by the Federal Reserve, have been noticeably less negative.
February was the sixth straight month of business inventories decline, clearing the way for a jump in production. Swings in inventories have become more muted in recent decades, reflecting improved inventory control technologies, but inventories still have cyclical potentials. This has compounded weakness in recent months, causing production to decline more than spending, setting the stage for the unwinding of inventory weakness to add to growth in coming quarters as the level of production moves up relative to sales.
Traditional leading indicators are still softening. The three-month change in the Leading Economic Indicators composite is still declining but at an increasingly slower rate. The decline in January was 0.7 percent, a revised 0.2 percent in February and 0.3 percent in March (subject to revision). The reduction in the rate of decline provides some optimism for growth in real GDP over the next 12 months. However, industrial and factory production disappointed in March. Capacity utilization stands at 69.3 percent, the lowest level since 1967 when this statistic was first recorded.
March’s 1.1 percent decline in retail sales also disappointed. Despite an improvement in consumer confidence, the domestic shopper appears unwilling to spend. Contributing to disposable income are the beginning of tax refunds, $13 billion of economic recovery payments to VA and Social Security beneficiaries, reduction of tax rates at the payroll level and surging re-financings of home mortgages. This later trend, with the reduction in mortgage interest rates, has contributed approximately $25 billion to consumers' pocketbooks. It is also estimated that the decline in oil prices since their peak is akin to a $500 billion tax cut.
The consumer has been paying down debt. It is estimated that outstanding credit card debt declined by 10 percent in February. Mortgage holders are taking advantage of lower re-financing rates, courtesy of the Federal Reserve’s actions of buying mortgage debt and the early signs of implementation of federal loan assistance programs. According to Freddie Mac, the average 30-year mortgage rate had fallen to 4.78 percent as of April 2, from 5.10 percent on Jan. 1 and down from the high point of 6.63 percent last July. Both existing and new home sales increased in February, off of record low levels. Yet there remain high levels of home inventories. Foreclosures will continue to weigh down housing prices. By some measures, there are still more declines to be expected in home prices and prospective buyers wait on the sideline for a better price. Affordability measures are at their lowest point in many years, indicating those with a regular income and funds for a down payment can find real estate they can afford. New tax laws also provide first time homebuyers with tax credits for the purchase of a primary residence.
And yet, the unemployment rate stands at 8.5 percent and is forecast to move higher. The peak in unemployment in this cycle has not been reached and forecasts call for a peak anywhere from 9 to 10.5 percent, depending on the forecaster. Unemployment is a lagging indicator, telling us what has happened rather than what will happen. As inventories continue to decline faster than sales, production will need to ramp up. If home sales work off recent lows, some consumer spending will increase. As the mood and the confidence of the consumer improves, spending will also improve, creating more sales and the need for additional production.
As with our diminutive back seat occupant, investors have been willing to accept some additional risk by purchasing a narrow sector of stocks. Possibly the assumption of this risk is just a way to pass the time as the markets, and the economy, move down the road. The unknown is the return to these investors over time.
Our small risk taker may not have factored in a negative return by the driver or by an older sibling occupying the front seat. Regardless, the destination will be reached, but will it live up to expectations?

David Helscher is a senior vice president and trust officer with Clinton National Bank.