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Forecast 2012: Grappling with Economic Uncertainty

Although credit has loosened up, both consumers and businesses are holding back on spending and cautiously heading into 2012.

2012 Directory
A new year has arrived, and with the turn of the calendar comes fresh hope. Will 2012 bring a more favorable business environment?

Economists advise tempering optimism with prudence. Consumers, financial institutions, and state and city governments are still struggling to right their balance sheets. The resulting financial squeeze is putting a damper on commercial activity - and that means business owners will likely encounter another challenging year.

"We are anticipating weak growth in 2012, with a gross domestic product (GDP) increase of some 2.7 percent," says Sophia Koropeckyj, managing director of industry economics at Moody's Analytics, a research firm based in West Chester, Pa.

At first glance a 2.7 percent rise in GDP might seem pretty good, given that the annual rate for an economy in average growth mode is 2.5 percent. Yet Moody's number can be misleading because it is calculated off a poorly performing 2011, in which growth only stumbled forward at an estimated 1.6 percent. Says Koropeckyj, "Coming out of a recession, we usually hope for well above average growth as pent-up demand is released and as businesses ramp up production and hiring." Koropeckyj also cautions that her firm's forecast could be too optimistic: "While we are still expecting a recovery in 2012, we now believe there is a 50-50 chance of lapsing into a double-dip recession during the first half of the year."

Consumers Hold Back
Moody's ambiguous forecast reflects the uncertainty prevalent throughout the economic environment. Both players on the marketing see-saw are taking breathers: Consumers are waiting for a decline in the unemployment rate and a bottoming out of the housing market before opening their wallets in appreciable numbers; and companies are awaiting a rebound in consumer activity before bolstering work forces and investing in new property and equipment.

"Unemployment remains high and wage growth is very slow even for people who do have jobs," points out Koropeckyj. "As a result, consumer spending has not been as strong as it could be."

And will the jobs picture improve? "The expected economic growth in 2012 is at a level which can absorb some unemployed people, but not too many," adds Koropeckyj. "So by the end of 2012, we are expecting the unemployment rate to be around 8.8 percent, not appreciably lower than the 9.1 percent level of late 2011." (Note: Unemployment actually dipped to 8.6 percent in early December 2011.)

Any improvement in the jobs picture will depend largely on policy decisions at the federal level, according to Scott Hoyt, Moody's senior director of consumer economics. "Under current law we will experience significant fiscal restraint [in 2012], with the expiration of both the payroll tax holiday and extended unemployment benefits. Those are the two factors that most directly impact consumers."

As for housing, consumers are wary of the continuing rounds of foreclosures and the high number of homes worth less than their mortgages. "Foreclosures and housing inventory remain quite high, maintaining downward pressure on home prices," says Koropeckyj. "We do not anticipate house prices hitting bottom until the end of 2012." The median price for existing home sales is expected to be $166,000 in 2012, about even with the $165,000 expected for 2011, which represented a decline from the $173,000 of 2010.

Housing starts are expected to reach 610,000 in 2011, up marginally from the 580,000 of 2010. The number may hit a little over one million in 2012. To put those numbers in perspective, housing starts were averaging 1.6 million annually before the current recession began in 2008.

Perhaps the most powerful force affecting the economy is psychological: People believe they are at the end of an era in which they could view their homes as sources of equity and as assets that would continually increase in value. Together, the moribund state of housing and unemployment weigh heavily on consumers. "The current state of consumer confidence is consistent with a severe recession," says Hoyt. "Consumers are very negative about the economic outlook."

Business Sits It Out
Until consumers come out of their funk, companies will be in no hurry to hire and expand. They are also being restrained by uncertainty about federal initiatives in areas such as the tax code, healthcare and financial reform, environmental and energy policy, foreign trade, and even the forthcoming presidential election.

"Given that frame of mind, it should be no surprise that no one is investing in new capital goods, or hiring," says Michael Smeltzer, director of the Manufacturers Association of South Central Pennsylvania, a trade group whose 1,000 members employ some 200,000 workers.

The fact is that most large and medium-sized businesses would rather accumulate cash than launch initiatives that might not pay off in a wobbly marketplace.

"What Roosevelt said about `the only thing to fear is fear itself' may have something to it," says Walter Simson, principal of Chatham, N.J.-based Ventor Consulting. "The fear in the business environment is palpable. People do not want to take dramatic action. They are afraid of a sudden drop in demand for unanticipated reasons, as happened in 2008." And there is enough anecdotal evidence about demand being choppy, adds Simson, that business owners are not thinking about what they should do to improve their operations. As a result, Moody's expects spending on new plant and equipment to increase by just 7.06 percent in 2012, down from the 9.61 percent of the previous year.

Hesitation to expand comes at a time, paradoxically, when credit for medium- and large-sized businesses is more readily available than a year ago. "Business credit is much like consumer credit," says Hoyt. "Well-qualified borrowers now have improved access."

Smaller businesses, however, face continuing hurdles. "Our small businesses are continuing to find it difficult to find reasonable capital," says Smeltzer. "The general machine shop - the small guy living week to week - that is where the problem is. And that's where the jobs are created; that's where the new ideas and the entrepreneurs start."

Corporate profits will also experience headwind: Moody's expects them to grow by some 3.2 percent in 2012, down from the previous year's 3.8 percent, which was itself a decline from a robust 2010. The de-escalation, says Koropeckyj, is due to a number of factors, including higher operating costs and lower productivity growth.

What productivity increase does occur is being maintained through restrained hiring and additional labor-saving machines. "Companies have found all sorts of ways to improve the way they operate with lean staffing," says Koropeckyj. "These process enhancements will remain in place, and will in fact prevent employment from rebounding to where it was prior to the recession for many businesses, even when output does rebound."

Labor Mismatch
Deciding to hire more people is one thing; finding the right people is another. And in this area, the labor market will present a growing challenge to both consumers and businesses.

"We are beginning to be concerned about what may be a chronic labor shortage," says Smeltzer. "The work force is getting older, and our data tell us that as many as 5 percent of our employees could retire every year. That's 10,000 people [out of 200,000 employees in the organization's member companies] with a high-quality work ethic and legitimate skills."

And who will replace them? Despite high unemployment figures, business owners are having trouble finding the workers they need. "Young people are not being trained in these skills, and a lot of the unemployed do not have the skills our businesses are looking for," says Smeltzer. "They are not inclined to go back to school to learn the skills. They just want jobs, and the ones they qualify for are lower quality than what they were used to."

"For decades we could just put a sign in yard for a machinist and get 20 qualified people," says Smeltzer. "Maybe today you get 100 applicants but none are qualified." While employers are seeing an increase in apprenticeship programs, they are concerned about the future. "The labor mismatch is not yet a crisis, but it is approaching one."

Poised for a Rebound
Despite the prevalent gloom and doom, the news isn't all bad. "Households have been de-leveraging, so their balance sheets are in much better shape," says Koropeckyj. "Mortgage rates are quite low, and banks are more willing to make consumer loans. There are more credit card originations, and there is also a lot of pent up demand." Indeed, Moody's expects a gradual loosening of credit standards to continue through 2012.

For their part, companies are accumulating a huge reserve of ready cash that can be quickly invested in growth when the game of chicken with consumers is finally over. In the meantime, small business owners are taking a "wait and see" attitude about the future. Until certainty returns to the marketplace, business owners will be wringing more revenues out of current operations, trimming operational expenses, and putting expensive expansion initiatives on hold.

"Sometimes business owners believe that if they want to grow, they have to venture into new areas," says Simson. "That is not necessarily true. Every company has its core products and customers. My advice is to identify your core customers and get closer to them. It is more profitable to cater to them than to try to expand into new areas."

Build on what you have, growing sales with existing customers, Simson advises. Maybe that's a dull strategy, but it might be the wisest course until the economic headwinds subside. "We are in for another year of `not a lot of excitement' from the viewpoint of the economy," concludes Smeltzer. "There is a lot of uncertainty, and the human reaction to uncertainty is to do nothing."

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