Looking back, the American consumers led the U.S. economy out of the recession of 2001. They kept buying houses. They kept buying cars. They kept buying clothes. They kept buying computers and cell phones. They even returned to the airports.
But now, American consumers are tired. They already have refinanced their debt and tapped out their home equity lines of credit. They also are absorbing a quadruple threat of rising energy costs, fuel costs, interest rates and health care costs.
Consumer bankruptcies and mortgage foreclosures are skyrocketing.
As consumer demand slows, so too will the U.S. economy in the second half of 2006, according to Clare Zempel, Milwaukee’s foremost economist.
Zempel founded Zempel Strategic in Fox Point after serving several years as the director of investment policy, chief investment strategist and chief economist for Robert W. Baird & Co. Inc. in Milwaukee (see accompanying Q&A).
Zempel expects the economy to continue to grow, but at a significantly slower pace of 3 percent for the remainder of the year.
“I see it cooling off. We’re talking about a decline in the level of housing activity. We’re talking about a slowdown, but not a collapse, in the growth of consumer spending. We’ll see negative surprises here and there, disturbing declines in home prices,” Zempel said. “It’s a question of the recent stock market weaknesses – is it a correction? Or is it telling us that the recession or stagnation argument is the correct one? In the late summer or early fall, there will probably be a sense of relief, that yes, things have slowed down, but there is no outright collapse.”
Indeed, both macroeconomic and microeconomic indicators are pointing to a dramatic “cooling off.”
With national debt at or near record highs, with a national trading deficit at or near record highs and with a nation at war, it’s difficult, at best, to predict anything but a slowdown in the second half of the year, especially when rising interest rates, energy costs and raw materials prices are putting inflationary pressures on the economy.
U.S. Federal Reserve Bank Chairman Ben Bernanke recently acknowledged that the American economy is entering a “period of transition” to slower growth.
“Real gross domestic product (GDP) grew rapidly in the first quarter of this year, but the anticipated moderation of economic growth seems now to be under way. Consumer spending, which makes up more than two-thirds of total spending, has decelerated noticeably in recent months. One source of this deceleration is higher energy prices, which have had an adverse impact on real household incomes and weighed on consumer attitudes. As had been expected, recent readings also indicate that the housing market is cooling, partly in response to increases in mortgage rates,” Bernanke told the International Monetary Conference in Washington, D.C.
“To be sure, the data on home sales and construction have been somewhat erratic from month to month, reflecting weather conditions, statistical noise, and other factors. However, overall, housing activity has softened relative to the high levels of last summer, and the rate of house-price appreciation appears to have lessened. A slowing of the real estate market will likely have the effect of restraining other forms of household spending as well, as homeowners no longer experience increases in the equity value of their homes at the rapid pace seen in recent years,” Bernanke said.
Peter Morici, a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission who serves on the Bloomberg and Reuters macroeconomic forecasting panels, cautioned the Fed about being too hawkish about inflation by continuing to raise interest rates.
“Although inflation is heating up, April and May retail sales, jobs and wage data indicate the economy is slowing, as do recent reports from the automobile, housing and construction sectors. International oil and commodities markets remain the most important sources of inflation, but those are beyond the reach of Fed policy. If the Fed acts too vigorously to contain inflation, it risks derailing the economic expansion and pushing up unemployment,” Morici said. “Recent rhetoric from the Fed indicates a much stricter monetary policy stance than in recent years. If the hawks have their way, the soft landing for the economy anticipated by forecasters and the Fed could turn into a recession. The economy could be facing a bout with stagflation.”
Indicators such as high energy costs, stock market valuations, rising interest rates and continued devaluation of the dollar point to an economic slowdown ahead, said Ron Miller, managing director at Cleary Gull Inc., a Milwaukee investment bank and consulting firm.
As a result, many of Cleary Gull’s clients who are thinking about selling their businesses are taking those businesses to market now, instead of waiting until next year, Miller said.
“Summer tends to be a slow period, but we’ve got five new pitches in the current period,” Miller said. “We’re pitching next year’s business now to take advantage of the current market and hope it continues through the end of the year. There are stronger warning signals now than there have been in the last 24 months of a slowdown.”
Michael Cleary, chairman and chief executive officer of Cleary Gull, said the signs pointing to an economic slowdown are similar to those he saw in 1999, shortly before a slowdown occurred.
“The same thing happened in ’99,” Cleary said. “People ignore them for a long time. Then there’s a little crack in confidence and they point to things they saw six months ago.”
National, regional and Milwaukee data and surveys are foretelling a significant slowdown is underway or lies just ahead. The only question that remains is whether the economy will have a soft landing or a hard crash.
• “Economically, things are slowing. GDP growth, after registering strong well above trend data for the first quarter, is slowing as the housing market and commodity price increases are registering a negative toll on the economy. We expect GDP growth to slow to the 3 percent range during the second quarter of 2006, followed by growth in the 2.5 percent to 3.0 percent range for the remainder of the year,” said Bill Greiner, chief investment officer of UMB Financial Corp.’s Asset Management Division, which has an office in Milwaukee. “All of this year, we have been consistent in the message that the economy was slowing and corporate profit growth rates were going to contract. This appears to be happening.”
• Lombard Street, a London-based economic research service with a strong track record, is predicting a hard landing for the U.S. economy. Lombard Street contends the odds of a U.S. recession in 2007 are now 50-50, depending on how hard the housing market crashes.
• Only seven of the 23 business activity indicators monitored by the Metropolitan Milwaukee Chamber of Commerce (MMAC) showed improvement in April, the lowest number since July 2003.
The MMAC index showed declines in employment, home sales and mortgages recorded.
The value of signed construction contracts in the Milwaukee area, as reported by F.W. Dodge for March, was $131.3 million, down a whopping 38.5 percent from the level of March 2005.
“Of late, Milwaukee-area indicators, particularly employment indicators, seem to be having difficulty getting on track,” said Bret Mayborne, economic research director for the MMAC.
• Nationally, housing starts in April were down 7.4 percent at an annual rate of 1.85 million, the third consecutive monthly decline and the slowest since November 2004, according to the U.S. Department of Commerce.
• The National Federation of Independent Business (NFIB), the largest coalition of small businesses in the country, reported that its Small-Business Optimism Index slipped in 1.6 points in May to 98.5.
“It’s hard to beat the first-quarter performance, so a slowdown is definitely going to happen. The only question is how far and how fast,” said NFIB chief economist William Dunkelberg.
• The latest Wisconsin Bankers Association (WBA) survey showed growing numbers of bank chief executive officers expressing concerns about lower disposable income, lower retail sales and an increase in loan delinquencies.
“Bankers have unique knowledge about the local economies they serve, which makes them the ‘canaries in the mine,’ as it were, of the Wisconsin economy. Bankers detect trends and potential problems in the economy before anyone else, even economists, because of their constant involvement and close relationship with community members and businesses,” said Kurt Bauer, president and CEO of the WBA.
• A growing percentage of U.S. housing markets are “extremely overvalued” and are at risk of falling prices, according to a study of government data by Global Insight and National City.
• Residential property foreclosures in southeastern Wisconsin soared more than 21 percent in the first quarter of this year, compared with the same quarter a year earlier, according to ForeclosuresWI. Statewide, the foreclosure rate increased 26 percent in the quarter.
• The Chicago Fed National Activity Index, a weighted average of 85 existing monthly indicators of national economic activity, dipped to -0.16 in May.
• Orders to U.S. factories for big-ticket manufactured items fell in May by 0.3 percent after an even larger 4.7 percent drop in April, according to the U.S. Commerce Department.
• The U.S. Leading Economic Index fell 0.6 percent in May, suggesting that the economy is likely to grow at a “slow to moderate” pace in the near term, according to The Conference Board. “The current behavior of the leading index so far suggests that the rapid pace of economic activity in the first quarter is unlikely to be sustained and economic growth should continue, but at a slow to moderate rate in the near term,” the Conference Board said.
Bruce Bittles, current chief investment strategist for Baird, said, “For the U.S. economy, a second-half slowdown is anticipated to drag GDP growth for the year to a range of 2.75 percent to 3.0 percent. Confirmation that economic weakness may already be underway can be found in the Conference Board’s Leading Economic Index.”
• The mood of U.S. homebuilders fell for the sixth straight month to an 11-year low in June, according to the National Association of Home Builders. The NAHB/Wells Fargo housing market index dropped four points to 42, its lowest point since April 1995.
• “Growth should ease as the housing market cools and consumers begin to exhibit more caution, bringing GDP growth to a below-trend rate of 2.7 percent in 2007, after 3.3 percent in 2006 … As usual at times of transition, uncertainty is high, and the U.S. economy’s landing may prove bumpier than anticipated. House prices have risen so far that they have made mortgage payments unaffordable for those on average incomes in many major markets (especially in the West),” stated the Wisconsin Department of Revenue in its June Wisconsin Economic Outlook. “Rising interest rates are now making the affordability problem worse. Leading indicators such as mortgage applications for purchase, sales of new homes, and sales of existing homes are now trending lower, albeit erratically. The slide in sales of existing homes will show up in more subdued spending on home furnishings and remodeling … For good reason, consumers feel stressed.”
SBT reporter Eric Decker contributed to this report.
