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Forecast 2008: Economy Slows, Housing Woes

In looking at the year ahead, most observers see a challenging environment where healthy profits will require nimble management.

Dec/Jan 08
Slowing sales. Higher costs. Tighter margins.
Ouch! Those unhappy trends were a three-legged stool of misery for many businesses in the past 12 months. Indeed, 2007 was a period of transition for an entire economy which began to slow after a half-decade of vigorous growth. And there's more to come.

Economy Slows
"We have a considerably weaker near turn outlook than we did a year ago," says Sophia Koropeckyj of Moody's, a research firm based in West Chester, Pa. "The economy will be performing below its potential until at least the end of 2008."

Just how far below potential might that be? The answer is reflected in forecasts for the Gross Domestic Product (GDP), the most widely used measure of economic health. Koropeckyj expects GDP growth to come in around 2.0 percent when 2007 numbers are finally tallied. That performance is well below the 2.9 percent recorded for 2006. Not much improvement, if any, is expected in the year ahead when GDP is forecast to grow around 2.3 percent. That's well below the 3.0 percent that economists say is the average rate of long-term growth in a normal economy.

And how about corporate profits? Those are expected to grow some 4 percent when 2007 numbers are finally tallied. That's a significant decline from the healthy 13 percent increase of 2006, a year that brought to an end a five-year string of double-digit increases. As for 2008, Koropeckyj expects 4.7 percent, not much better than 2007.

Housing Woes
What's the problem here? Several villains are playing lead roles: the erosion of the housing market, high fuel and commodity prices, and the continuing struggle by business owners to put a lid on labor and medical costs.

Housing woes, of course, have hit the headlines big time. "The major weights on the economy have been the implosion of subprime mortgages, the downturn in the housing market and the resulting decline in building activity," says Koropeckyj. Look for more ahead. "Problems with the housing market are not going to disappear overnight. They will affect the economy through the end of 2008."

Manufacturers tied to the housing industry have felt a tremendous impact. "Building materials and construction equipment manufacturers have been squeezed between softening demand and higher raw materials and energy costs," says Koropeckyj. "They have been cutting jobs and that is likely to continue."

The decline in the turnover of existing homes is expected to bottom out by early 2008. But the related home construction activity that is so important to the economy is not expected to turn around until well into the year. As for the troubling housing price slide, that's not expected to hit bottom until the end of 2008.

Perhaps the most serious elements of the housing market crisis are the interest rate resets now putting financial pressure on homeowners. These haven't peaked, says Koropeckyj: "There will be more foreclosures, and that could have a serious impact on the economy."

Financially strapped homeowners, of course, shop less. But there's another reason the mortgage meltdown affects business owners: Financial trauma can erode an employee's workplace performance. "All of these repossessions are impacting workers," says Don Schackne, president of Personnel Management and Administration Associates in Delaware, Ohio. "Many of my clients are struggling with how to respond. How much should they try to salvage an employee's problems with corporate money which was not meant for that purpose?"

Energy Prices
High prices for gasoline and heating oil have continued to plague consumers over the past 12 months. The sticky nature of high energy costs took economists by surprise. "The fundamentals would suggest that prices would be falling as moderating demand combines with an increase in supply," says Koropeckyj. "And yet oil prices have remained high."

Speculative activity is one prop for energy prices, according to Koropeckyj. A second is the continuing risk premium from political events. A third is the strong demand from the fast growing Chinese and Indian economies. "Insatiable appetites from China and India have also driven other commodity prices - from copper to steel to aluminum - to record highs," she says. Little improvement is expected in the year ahead.

Labor Costs
One major positive factor is propping up the economy: healthy wages. expects a wage growth figure of some 3.5 percent when 2007 figures are in, up from the 3.0 percent of 2006. The figure for 2008 is expected to be 3.2 percent. These wage increases are a result of pressures on employers from the low unemployment rate, which has been hovering around 4.5 percent. It takes more money to find and retain good people.

That, of course, is just the problem. On one hand, robust wage growth is good because more money in consumer pockets stimulates shopping. On the other, business owners feel squeezed between escalating payrolls and customer resistance to price increases in a decelerating economy. "We do not feel confident in our ability to raise pricing," says Michael Smeltzer, director of the Manufacturers' Association of South Central Pennsylvania, a trade group whose members represent primarily smaller manufacturers in a broad range of industries. "That is a major area of concern as we have focused on cost control."

This concern is pretty much nationwide. "Wage growth is rising at a rate faster than inflation, which is rising some 2 or 2 1/2 percent," says Ken Goldstein, an economist at The Conference Board. "That's been the case for a couple of years and is not likely to change in 2008. As a result, business owners foresee a negative impact on profits."

Given the predictions of low unemployment through 2008, upward pressure on labor costs should continue. "The `Help Wanted' signs are out," says Schakne. "We are not hurting for jobs but we're hurting for qualified employees to fill them. In many respects we are right on the edge of the unemployables. Employers are refusing to hire the applicants they are seeing."

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