• National Economy- The Good News: Economic indicators are getting progressively closer to the point where I'll be willing to call the current environment the initial stages of recovery. Job losses have been getting smaller and smaller throughout the fall, even though the monthly numbers continue to bounce around a bit. Remember that the U.S. employment numbers are seasonally adjusted and hence are vulnerable to untypical fluctuations. The most recent job loss of 85,000 jobs was mostly a phenomena associated with less job growth in December than typically occurs during the holiday season. Furthermore, the holiday hiring that did occur, happened early in October and November, artificially reducing the net job losses in those months.
Initial claims for unemployment are also dropping, but still remain too high. Most indicators such as the Purchasing Managers Index and the Index of Leading Indicators also point toward further improvement in the national economy. Furthermore, an increasing number of firms are now raising their outlook for 2010 as new orders continue to improve.
• National Economy - The Bad News : But the problems in the national and global financial markets are not likely over. Increasing numbers of banks are being closed by the FDIC. Scattered European nations are on the brink of financial collapse which is hurting the EU overall. Many state budgets are in severe distress and will most likely result in significant reduction of state and local government jobs. Mortgage delinquencies continue to rise and stress in the commercial real estate market is increasing at an alarming rate. The prognosis that the recovery will continue to be weak for some time seems to be right on target.
The Houston Economy Continues to Surprise
• Employment: Recently released data for Houston show that year-over-year job losses in Houston are about 88,000 jobs. This is the worst local labor market performance since the 1980s. However, it appears that job losses ended this summer. Since August seasonally adjusted employment is actually up 2,700 jobs. That's only a 900 net increase in employment per month, but it is far better than the approximate 20,000 per month Houston was losing in the early part of this year. Most sectors of the economy are outperforming expectations, even those such as construction, retail and finance which continue to lose employment. The biggest surprise is the growth in the leisure and hospitality sector which was expected to shed jobs through most of 2010. Nonetheless, we are warning the reader to be prepared for another downward revision in 2009 employment numbers when they are released in March, though our expectation is that those revisions will not be as dramatic as in the past.
• Oil Prices: Relatively high oil prices continue to be a bright spot for Houston . Current prices for crude in real dollar terms are about 50% higher than they were in 1980 at the peak of Houston 's decade long energy boom in the 70s and very early 80s. This is particularly surprising given that overall global growth remains anemic and that OPEC has had to hold back so little of its full production. This makes one wonder what prices will do once the global economy strengthens. High oil prices are certainly helping the white collar portion of Houston 's upstream energy economy which has lost only about 2,000 jobs off of last year's peak.
• Natural Gas Prices: Unfortunately, the same can't be said of natural gas prices. They still remain low for this time of year, especially given the national cold spell that has lasted far longer than usual. Since a vast majority of domestic fossil fuel exploration and production is for natural gas, this does not bode well for manufacturers of oil/natural gas field equipment (the blue collar portion of the upstream energy economy). However, even here the current employment statistics show that job losses in durable goods manufacturing are also slowing down substantially. Nonetheless, I don't expect to see job growth in the overall regional manufacturing sector during all of 2010.
Partly because energy prices present such a mixed story right now, one should not think of this local recession in terms of an “energy bust”. Job losses have been wide-spread, more representative of a full-fledged recession and not one attributable to any particular industry. But, an important bottom line for Houston is that energy is simply not likely to be the dominant driver of the regional economy in the next 2 or 3 years as it was between 2005 and the first half of 2008.
• IRF Versus GHP Forecasts: There has been some confusion of late regarding my forecasts at the IRF's November Symposium versus the Greater Houston Partnership's forecasts released in December. We indicated a .5% drop in employment for 2010 and the GHP forecast a minuscule amount of growth. On the surface, it appears that the GHP is somewhat more optimistic than I, which is not unusual. But that is not the case. The GHP's forecast is for December 2010 versus December 2009. The IRF forecast compares the average level of employment for all of 2010 versus the average level of employment in 2009. Were you to convert the IRF numbers to show their approximate monthly implications, it would turn out the IRF forecasts are actually more optimistic than those of GHP. In the November report we saw growth in jobs returning to Houston by the second half of the year and December-to-December growth at 1.7%. See my commentary at http://www.uh.edu/irf/Commentary28.htm for a complete explanation of the difference.
• Strength in Home Values : One of the surprising findings reported at the November IRF symposium was that home values are holding up quite well in Houston . More precisely, while foreclosed home sales are heavily discounted, the non-foreclosure market (about 70% of all home sales) shows home values about where they were at their peak in 2007. This is good news for the overall economy because it means that Houstonians have taken a much smaller hit to their wealth than most other Americans, and hence this bodes well for retail sales in the region. Nonetheless, it also should be noted that recent data suggest that Houston foreclosures are again rising and that there may be an explosion in new foreclosures in the next couple of months, so we'll have to watch the Houston housing market carefully.
Underlying Assumptions About the Near-Term
• Slow and Irregular Recovery, But with an Upward Trend. Many recessions are followed by a sudden, sharp rebound. That will not happen this time. There remain too many unresolved issues for both the national and local economy for the recovery to proceed swiftly. Global, national, and local financial sectors remain under significant pressure. The housing crisis is still not over and will soon be accompanied by a commercial property crisis. Too much weight is being put on the hope that Asia will lead the global economy towards a strong economy. Even if Asian economies continue to grow, they will not provide much stimulus to the “western world”. But in addition to that reality most analysts also remain way too optimistic regarding Asian prospects. Thus, one should permanently shelve the “Asia-to-the-rescue” scenario.
• Worries About the End of the Stimulus Plan : An key unknown right now is that we still don't understand exactly how the national economy will do as many federal stimuli come to an end. Car sales rebounded nicely after the September slump when the “cash for clunkers” program ended, but new home sales are likely to weaken significantly when the “first time home buyer” tax credit expires at the end of April accompanied by an end to the Federal Reserve Bank's purchase of mortgage backed securities which have kept mortgage interest rates unusually low. Today's data, showing a stabilization of the national economy, is somewhat distorted by the presence of a variety of federal government stimuli which can't last forever. Fortunately for the near-term stimulus spending will actually be greater in 2010 than 2009. Still, a real recovery must be one in which the economy can once again stand on its own feet and we might not get a full sense of that until 2011. This is another reason why the national and local recoveries will unfold quite slowly.
• The Beginning of a Fed Reversal . The biggest change in government policy will be the change in Federal Reserve Bank policy. While I don't expect the Fed to raise its standard interest rate, the federal funds rate, I do expect them to completely stop the extraordinary purchase of private debt. Always in the past the Fed has bought Treasuries when they wanted to increase liquidity and expand the money supply. The purchase of mortgage backed securities and commercial paper was unprecedented. The purchase of new private debt will almost certainly end during the first quarter of this year, and before the year is over the Fed will start unloading much of the private debt they currently own. This will greatly affect the spread between long and short term rates and between private and public sector rates. It will be important to see how the economy and the stock market respond to this significant change. At this point it is assumed that the stock market will not have a stellar 2010 and that while job losses will end early in 2010, job gains will be sporadic across sectors and on net quite modest for most of next year.
• The Link Between the National Economy and Houston : The IRF HEMS model forecast for local employment is based upon the assumption that the national economy (GDP) and national employment will be quite modest next year. As a result, while we will see some rebound in jobs in Houston during the second half of this year, job growth will look weak in comparison to much of this decade. Furthermore, the 1.7% year-over-year job growth in December as previously alluded to will be somewhat artificially inflated by the fact that the December 2009 base is going to be so low. Still, keep in mind that while the Houston economy has fared better than other parts of the nation, Houston is not at all immune to any new national economic bumps along the way.
• Oil Prices Steady; Natural Gas Prices Weaken Again . Our current view of Houston 's prospects also assumes that oil prices will remain steady within the $70 to $80 per barrel range, but that natural gas prices will weaken again as spring approaches. As of this writing the futures contract for July delivery for oil is $84.14/ barrel. That seems slightly high and appears to be a bet on a stronger global economy than I am expecting. But, the futures contract for natural gas for July delivery is far too high at $5.91/ mcf. That is higher than current levels, despite colder than normal weather this winter. With all of the excess supply in the market it seems that July natural gas prices are going to struggle to stay above $4/mcf.
• As with the Nation, Problems with Commercial Real Estate will Mount. The next financial hurdle to face the nation and Houston will be a serious drop in commercial real estate prices along with foreclosures and bankruptcies due to the inability to refinance commercial properties. For the financial sector this spells more trouble. For construction it means more contraction as new commercial building activity will nearly come to a halt.
Caveats
• Continued Uncertainty. While this is repeating much of what was said at the November Symposium, let me remind the reader that the forecast presented here represents the most likely outcome. There still remains a significant amount of uncertainty regarding the future, though that uncertainty is gradually diminishing over time. While all contingencies can't be covered in this commentary, one should be aware of what I consider are the key downside risks to this forecast.
• The Tipping Point from Stabilization to Growth. It is one thing to document improving stability in the national and local economies, and another to see the development of actual growth. At this point we can only be confident of the former. A major question that all analysts are asking right is how soon the U.S. and world economies can go it alone without continuing government stimuli. As world governments find economic stimuli increasingly burdensome to fiscal responsibility and hence are forced to pull back, some are suggesting that after a modest rebound during the first half of 2010, the U.S. economy could fall back into a recession, roughly similar to the double-dip recession of 1979-82. While I recognize this possibility, this recession has accomplished much more than the initial recession of late 1979 and 1980, so I believe a second collapse is not likely in the works. Still, a very slow recovery is certainly a real possibility.
• Trade War. In November I also pointed out that another scenario worth watching for is the possibility that the world finds itself engaged in a trade war of protectionism. Most nations of the world have committed to avoid this, but signs of protectionism across the world are already appearing in subtle forms. Since November this trend has only accelerated. Even the debates in Copenhagen carried with them protectionist sentiment that sought to push climate controls on to other countries. Protectionism will unfold slowly enough that it won't affect the immediate future, but wisdom requires that this potentially disastrous shift in policy be watched for with all diligence since it could have serious repercussions within a few years.
• Need for an Exit plan. Perhaps most worrisome for me is the possibility that the U.S. and Europe fail to develop a comprehensive exit plan that remedies the causes of the past crisis and weans government out of its role as the primary source of increased aggregate demand. Changes in economic policy take a considerable amount of time to evolve, so governments throughout the world need to start now to plan for a more normal future. Right now both the Obama administration and Congress are predicting an accumulative deficit of $9 trillion over the next 10 years. That's nearly a trillion dollars per year. Such a scenario would be disastrous and would almost certainly quickly derail any recovery and rekindle another bout of world-wide financial panic. Thus, we will have to carefully monitor the evolution of federal fiscal policy for the future both here and abroad to determine whether it will allow the nation and the global economy to return to sustainable growth.
State Crises. Another potential problem for 2010 is the rapidly growing financial crises for about half of all state governments and many local governments. While it is too early to worry about an actual default in state or local bonds, the fact is that many states face huge deficits that will be very difficult to eliminate. Most accounting tricks have been exhausted, leaving these states with the choice of either increasing taxes or drastically reducing services. I'm betting that the latter will be attempted first, boding poorly for public sector employment over the next 2 years. However, there is one other scenario that I find equally worrisome. It is a scenario in which the Federal Government gets coerced into bailing out these governments, thereby not really solving the problem, but simply pushing more and more burden upon that national government. States like California that thought they could live forever on double digit property value increases need to face up to their own fiscal problems.
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Dr. Barton Smith
Director, Institute for Regional Forecasting
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