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Economic Forecast: What Lies Ahead in 2015?

Although there are some trouble spots on the horizon, economists are upbeat about the economy; some key indicators will reveal the outcome.

Q4 2014
Predicting the future of the economy is notoriously difficult. A year ago economists were promising a fairly robust 2014, with prognosticators at Moody’s Analytics, a research firm based in West Chester, Pa., pinpointing the year’s growth in Gross Domestic Product (GDP) at 3.1 percent. Things didn’t work out that way: The country is expected to record a disappointing GDP of 2.2 percent when the year’s numbers are finally tallied.

Hope, though, springs eternal. As the nation turns the calendar once again, a new round of forecasts is under way, and once again the skies seem to be looking a bit sunnier. The economic environment is characterized as “encouraging” by Sophia Koropeckyj, managing director of Industry Economics at Moody’s Analytics.

Koropeckyj points to a number of favorable factors: “Housing prices are rebounding, job growth is getting stronger, stock values have been at record highs, and people are enjoying record low debt service burdens.” Those factors feed into consumer spending — that vital driver of economic health for businesses of all varieties. And more important for long-term growth, large corporations are exhibiting a willingness to invest in infrastructure. Housing prices are rebounding, job growth is getting stronger, stock values have been at record highs, and people are enjoying record low debt service burdens. Sophia Koropeckyj, Managing Director of Industry Economics, Moody’s Analytics A Healthy Climate…With Trouble Spots
If those trends continue, the country should enjoy a fairly healthy 2015. Moody’s is predicting a GDP increase of 3.5 percent for the year. To put that number in perspective, an economy in average growth mode is 2.5 percent.

Of course, no one can say that unexpected bad news won’t dampen the picture. That’s what happened in 2014 when severe winter weather caused a variety of issues, from consumers staying home to breakdowns in the supply chain. That was followed in the summer by a surprise hike in interest rates, caused by some misinterpretations of comments from the Federal Reserve about the end of quantitative easing.

So what could happen in 2015? There are a number of possibilities. The first is an echo from 2014: a surprise hike in interest rates. That would dampen the recovery in housing. “If housing markets do not gather momentum we might not get the anticipated construction and jobs,” says Scott Hoyt, senior director of Consumer Economics for Moody’s. Also, the financial sector might go south. “There is a danger that the banks are not in any better shape than they were in 2008,” says Walter Simson, principal of Chatham, N.J.-based Ventor Consulting. He points to a number of other factors that might spark the next economic disruption: a large terrorist attack, a flare-up in the Middle East, further softening of the European economy, and a rapid spread of Ebola. All of these are part of what Simson calls “a dangerous world.” Any one of them can interrupt business activity and cause consumers to stay home instead of go about their business.

Housing Improves
Barring a disaster, though, key parts of the economy seem to be setting the stage for a productive 2015. Another key driver of the nation’s growth is housing activity — a sector that is gradually improving. In 2015 the nation should see housing starts increase to 1.5 million units — a good increase from 2014’s figure of 1.1 million, according to Moody’s. Any improvement is welcome, but Koropeckyj notes the number is still below some historic benchmarks. In 2005, for example, the number of housing starts was 2.1 million.

However, housing starts could still fall short of expectations. “There are many constraints on homebuilders’ willingness and ability to ramp up quickly,” explains Koropeckyj. “These include the availability of construction and land development loans, labor shortages, and a lack of manufacturing capacity for certain building materials.” Economists also like to look at sales of existing homes. Here, the results have also been improving, if not spectacular. “Sales of existing homes have been slow to ramp up because credit availability remains very restrictive,” notes Koropeckyj. There are many constraints on homebuilders’ willingness and ability to ramp up quickly..these include the availability of construction and land development loans, labor shortages, and a lack of manufacturing capacity for certain building materials. Sophia Koropeckyj, Managing Director of Industry Economics, Moody’s Analytics Consumer Confidence
The gradual improvement in housing is seen as a spur to consumer confidence, a vital driver of economic health. “Consumer confidence has been sort of ‘inching up,’” says Hoyt. “It has not risen a lot, but we are — by most measures — near post-recession highs. As conditions continue to improve, and as the unemployment rate comes down and we see growth in wage rates, confidence should be higher. That will facilitate the release of pent-up demand and greater spending.”

The slowly improving employment picture is cheering consumers. Moody’s expects unemployment to fall to 5.7 percent by the end of 2015. And economists expect “full employment,” which they define as an unemployment rate of 5.5 percent, to be reached by the end of 2016.

A cheerier jobs picture means that consumers should be more prone to buy over the next 12 months. “Core retail sales should increase 6 percent in 2015,” says Hoyt. (Core retail sales exclude volatile revenues from auto sales and gas stations.) “That’s a significant increase from the 3.9 percent rate expected to be recorded when 2014 numbers are finally tallied,” he notes.

Those numbers are pretty impressive, given that in the period just prior to the 2008 financial crisis the comparable figure was only 4.6 percent. Why are consumers rebounding so quickly? “Part of the reason is that 2014 has been stronger than the reported 3.9 percent retail growth rate suggests,” says Hoyt. “The weak first quarter in 2014 artificially depressed the year’s results.”

Of course, the consumer has plenty to worry about. There’s still a lot of give in the labor market, and plenty of part-time workers would like to have full time jobs. Even so, the consumer is happier than a year ago and merchants are starting a new year on pretty good footing.

“With employment growth what it is, income growth should tick up,” says Hoyt. “Construction should also pick up: We are not building enough houses to meet the demand as evidenced by the rapid increase in housing prices. Builders will catch onto that, and it takes a fair bit of labor to build homes. That will further support the job market.”

Movers and Shakers
When large corporations take action, the ripples are felt throughout the economy. Economists are looking for the big players to stimulate the marketplace by investing in new capital equipment, expansion, and hiring. Like consumers, big corporations are expected to rebound in the months ahead. “Record profitability, rising utilization and falling vacancy rates, extraordinarily low borrowing costs, and increasing access to credit are lifting investment in equipment, software, and buildings,” says Koropeckyj.

Big employers are looking at more investment in 2015, partly because they seem to have reached the limits of what they can squeeze out of their current assets. “Businesses are approaching a point when they can no longer increase profits by just cutting costs,” explains Koropeckyj. “They need to take chances, introduce new products, expand to new markets, enter new partnerships, or fund bold new ideas. Recessions typically make businesses reluctant to take such risks. However, with the recession more than five years in the rearview mirror, times don’t feel as scary.”

All that spending can boost the economy in a way that helps all businesses. “Real investment spending growth is expected to pick up from 4.9 percent in 2013 and 5.8 percent in 2014 to 8.6 percent in 2015,” says Koropeckyj. As for hiring, she notes, “Job openings rates have surged in recent months, at times as high as those during the best times of the last business cycle.” Construction should also pick up: We are not building enough houses to meet the demand as evidenced by the rapid increase in housing prices. Builders will catch onto that, and it takes a fair bit of labor to build homes. That will further support the job market. Scott Hoyt, Senior Director of Consumer Economics, Moody’s Analytics Increased confidence is expected to add fuel to the corporate fire. “Business confidence surveys generally reflect that firms see better times ahead,” she adds. Corporate profits are expected to increase by 12 percent in 2015 following an actual decline of 0.4 percent in 2014 caused by an extremely weak first quarter.

And how about the smaller players? They, too, seem to exhibit more of a willingness to take risks. “At smaller companies growth has been slow but steady,” says Simson. “Now businesses are showing tentative willingness to expand as opposed to three or five years ago, when they were afraid banks might unexpectedly call in their loans. Retailers, for their part, are fairly busy. They are building additional stores, hiring more people, and increasing hours. I see a continuation of that trend.”

Reports from the field corroborate an improving outlook for business. "Sales continue to see a positive trend in the near future for manufacturers, and backlogs have recovered with new orders either stable or increasing,” says Tom Palisin, executive director of The Manufacturers' Association, a York, Pa.-based regional employers' organization with more than 350 member companies. “With the continued positive growth of the U.S. GDP, the domestic markets for manufacturers will continue to see growth opportunities.”

At the same time, says Palisin, there has been increased interest on the part of manufacturers to bring production back to the states — a trend that can only lead to higher consumer confidence. “Recent offshore labor cost increases, declining U.S. energy costs, and geopolitical events have resulted in U.S. manufacturers reconsidering U.S. production, especially when the total cost of production is analyzed.” Manufacturers are feeling the constraints from a shortage of skilled talent…Without an ability to find and fill key skill positions, firms are less able to increase production capacity, take on new orders, or seek out new customers and markets. The forecast for the skill gap is that it will continue to hinder expansion Tom Palisin, Executive Director, The Manufacturers' Association The sticking point for manufacturers remains the poor quality of the labor market. “Manufacturers are feeling the constraints from a shortage of skilled talent, especially in key areas like industrial maintenance, machinists, skilled fabricators/welders, and industrial engineers…Without an ability to find and fill key skill positions, firms are less able to increase production capacity, take on new orders, or seek out new customers and markets. The forecast for the skill gap is that it will continue to hinder expansion,” Palisin notes.

Looking at Key Predictors
As businesses enter the early months of 2015, they may want to watch for some key predictors of how the year is going to shake out. One such indicator is housing: Will it continue to improve in terms of sales and prices? A second one is bank lending: Are financial institutions more willing to lend than in the past? “Improved mortgage credit availability will be the key in enabling the housing market to take off,” says Koropeckyj.

Perhaps the most important leading indicator, though, will be job data. Improving employment numbers will be a vital boost to consumer spending. “People will be looking for continued job growth in early 2015,” says Simson. “If they see it, they will think things are going well. If job growth is not there, people will be worried that something is amiss.”
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