Many clients ask where we think the economy will be in the next twelve to twenty four months? We are still seeking that crystal ball that comes with an accuracy guarantee stamped on the box. Until then we need to rely on government statistics and other data points to try and form a reasonable conclusion. The fresh data out last week is not giving us the all clear signal that many are looking for. Consumer confidence after rising for the past three months declined sharply in June down to 52.9 from 62.7 in May. The ISM (Institute of Supply Management) manufacturing index declined along with a new and existing home sales (record lows). On Friday the unemployment numbers were released and indicated, after a downward revision last month, a total of 116,000 private sector jobs were created in the past two months. The unemployment rate dropped to 9.5%, not a good thing because over 1,000,000 people have thrown in the towel and stopped looking for a job. If they were still looking the rate would be about 11%. On the personal earnings front the trend down continued, average hourly earnings and hours worked dipped slightly.
The National Federation of Independent Businesses chief economist, Bill Dunkelberg, released his latest survey indicating over the next 90 days, 8% of businesses will reduce employment (up 1%) and 10% of businesses plan on creating a new job (down 4%). Seasonally adjusted, just about 1% of business owners plan on hiring. This was the second positive reading in nearly 2 years but it was a measly one that certainly does not point to a V bottom growth pattern. The economy needs to create over 200,000 jobs a month for the next three years just to get back to par from when the “Great Recession” started. On top of that is the 125,000 jobs needed to keep up with the population growth, one example, high school and college graduates entering the work force.
Moving into a more broad analysis, we need to keep in mind several additional factors that will add weight to the already stretched thin economic cord. According to LPS Analytics there are 1.7 million foreclosures in process in which the borrower being delinquent, on average, for 438 days before eviction. LPS also states there are 650,000 borrowers who have been delinquent for at least 18 months. By living rent free for a year and longer, we can crudely estimate how much spending these delinquent borrowers contribute to the economy on a monthly basis. (1,700,000 x $150/month = $255,000,000/month). Even at half that amount, it is a large enough number to have an impact when the free housing ends. Another consideration is the fiscal health of towns, cities and states, as we all know, few are running budget surpluses. Therefore more layoffs and cuts will need to be made adding to the unemployment rolls and real estate woes. In an effort to combat government deficits municipalities are also raising taxes and fees which is leaving fewer dollars in its residents pockets. At the federal level there is continued uncertainty about taxes, the costs of the new healthcare reform bill and the levels of spending that is taking place.
“Austerity measures”, the latest buzzword making the rounds, has taken hold in Europe as they realize no matter how hard you try, when coming off a period of record levels of debt, its difficult to borrow and spend your way to economic growth. Austerity measures will jump the pond and arrive in the United States soon. Failure to implement them will cause interest rates to rise as investors move money out of US dollars and its treasuries into those countries that are getting their books in order.
To stock market investors this chart from Trend Macrolytics may send chills down the spine. It depicts, in orange, the path the S&P 500 took in 1937 after reaching recovery highs. Note how eerily similar the path today (red line) is tracking the S&P 500. In 1937 a recovery appeared to be in full swing after a disastrous depression. Much like the “green shoots” exuberance of this past spring after coming off a dismal 2009. In 1937 President Roosevelt and his administration frightened by government deficits cut spending (“austerity measures”), raised taxes, and implemented an anti-business and heavy regulatory environment. In addition the Fed raised reserve requirements. Sound familiar? Like the red line in the chart above, the current administration is right on cue. Although Bernanke will not raise reserve requirements, the Dodd-Frank financial reform bill will result in banks having to sock away more cash as well as conform to many new regulations.
We anticipate a growing trend in which investors shun the Wall Street shenanigans and look to other investment opportunities such as real estate and the purchase of businesses. This has been evident as iMerge has closed six transactions thru June, a pace that was last equaled in 2007. Sellers do need to be cautioned that this is a buyer’s market in which reasonable multiples of EBITDA for today’s economic climate are being paid. The days of buyers accepting 15% – 20% annual return on their investments (5-7X) for deals under $10,000,000 went the way of Lehman Brothers. To coin a phrase by analyst, John Mauldin, we anticipate being in a “Muddle Through Economy” for the next few years.
Stay tuned for our 2011 forecast coming in six months.