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Economic Forecast 2013: Overcast with Clearing Skies

Consumers have trimmed their debt loads and large corporations are creating treasure chests of cash to invest when market uncertainties are resolved; businesses should take steps now to position themselves for a revival of activity.

November 2012
Overcast with clearing skies. That’s the economic forecast as the nation enters a new year. Drizzly conditions will remain at least for the first half of 2013 as consumers hold tight to their pocketbooks and commercial activity is constrained. Light should break through the clouds in summer and fall, though, as the resolution of critical uncertainties encourages corporate hiring, capital investment, and consumer spending.

The coming year as a whole is not expected to bring significant relief over 2012. “We expect the recovery to remain lackluster,” says Sophia Koropeckyj, managing director of industry economics at Moody’s Analytics, a research firm based in West Chester, Pa. “The pace of growth will be too slow to meaningfully bring the unemployment rate below 8 percent.”

The numbers tell the tale. The most common measure of the nation’s economic health is growth in gross domestic product (GDP), the annual total of all goods and services produced in the United States. Moody’s expects GDP to increase by 2.4 percent in 2013. That’s not much of an improvement over the 2.3 percent anticipated for 2012 when figures are finally tallied. Moody’s forecast might not seem all that bad, given that the GDP increase for an economy in average growth mode is 2.5 percent. But there’s a problem: A nation recovering from a recession needs more robust expansion. “By most measures, this recovery is among the weakest in the past 50 years,” says Koropeckyj.

Consumer Confidence Lacking
What’s holding things back? Koropeckyj points to a number of areas. “Fiscal restraint on the local and national level, weaker global demand, a housing market that has hit bottom but has a long way to go to become healthy, and weak income growth are all constraining a stronger pickup in employment.” Other factors are the weakening economies of China and Europe — both important markets for U.S. exports.

All those factors are coming together to subdue the public mood. “Consumer confidence is still at a level consistent with a recession,” says Scott Hoyt, senior director of consumer economics for Moody’s. “Consumers remain concerned about economic conditions. There is still over 8 percent unemployment, weak growth in wages, volatile stocks, and high gasoline prices. There are a lot of things to keep consumers on edge.”

While consumer confidence spiked upward a little in early fall, public jitters will only be reinforced by the major weight of a constraining federal fiscal policy. Consumers will be impacted in particular by the anticipated termination of two initiatives: the social security payroll tax holiday and extended unemployment insurance benefits. Reduced federal spending, by eliminating some jobs, will also have an indirect but significant effect on consumers.

Given these depressants, Moody’s expects the nation to muddle along through the early months of 2013 as the fiscal policy debate heats up, with some improving performance expected in the summer.

Corporate Profits Up, But Investment Down
If the economy remains troubled, many large corporations have managed to thrive. Indeed, they have been piling up hordes of cash to position themselves for a fresh round of capital and labor investment when the market rebounds. “Businesses are in excellent financial health; their costs are down and they have become highly competitive and profitable,” says Koropeckyj. “Employers have little slack in their labor forces so layoffs have declined dramatically.”

Reports from the field reinforce this assessment. “Of the one thousand or so companies that we watch closely, sales generally are strong,” says Michael Smeltzer, executive director of the Manufacturers Association of South Central Pennsylvania, a trade group whose members employ some 200,000 workers. What remains weak, though, is “backlog,” or sales booked for future delivery. “Customers are only buying what they need to buy, but are not buying for the future, not building up inventory. As a result, businesses are not investing in capital or people.”

In other words, people are unsure about what lies ahead. “A number of issues collectively depress consumer and business confidence,” says Smeltzer. “Will healthcare reform remain in place, and what will be the impact if it does? What will federal tax policy be? Will the fiscal cliff arrive? What will be the effect of any sequestration having to do with federal deficit reduction?”

Challenges Ahead

Those uncertainties prevent corporations from hiring the people they need for future growth. And that brings up another problem: A lack of requisite skills in the labor pool. “There is no improvement in the chronic labor shortage — it has worsened,” says Smeltzer. “There is a mismatch in that employers have job openings that they cannot fill. As a result of technology many of the unskilled labor positions that were stepping-stones have disappeared. We now have robots doing the building.”

Another depressant to expansion is the scarcity of reasonably priced capital. “Those that don’t need capital can get it,” says Smeltzer. “But small machine shops are struggling to get access. And when capital is available for the small company, terms are not good.”

The reason is recent history. “Financial institutions tend to look at the past three years of performance when considering loans,” says Smeltzer. “If you look at the manufacturing sector, two of the last three years have been not so good. Therefore, the financial institutions say it is too much risk, so if I am going to lend you money, the terms will be biased on my side.” For their part, companies are not waiting for uncertainties to be resolved and banks to come around. They are showing signs of a new vigor in revenue building that can only serve to improve their standing with financial institutions.

“On the cost side, businesses have gone about as far as they could go,” says Smeltzer. “So they have to focus on the sales side. Businesses need to be in a much more aggressive development cycle, going after new customers and new product development. I feel very good that the majority of them have warmed up to the fact that it is their responsibility to go out and develop new sales opportunities.”

Housing on the Mend
And what about housing, that all-important driver of economic health? While still far from healthy, it’s on the mend. “Residential construction and home sales have been trending up since mid-2011,” says Koropeckyj. “Residential construction-related jobs are also slowly creeping up. The months of inventory of new homes are low, having fallen below five months, and existing-home inventories have stabilized around 6.5 months, not far from the normal rate.”

Thanks to tightening inventories, housing prices are showing signs of a rebound after a dismal few years, says Koropeckyj. “Other signs of a healthier housing market include a rapid decline in the rental vacancy rate, stabilization in homeowners’ equity, and low early-stage mortgage delinquency rates.”

Additionally, says Koropeckyj, record low mortgage interest rates and the expansion of the Home Affordable Refinance Program are boosting mortgage refinancing. “That will help to free up household cash to spend on other consumer goods as well as prevent some additional foreclosures.”

Nonetheless, housing, while improving, remains challenged. Most members of the National Association of Homebuilders feel market conditions remain poor. Home construction, in general, is barely up from a 40-year low. Home sales remain near their 1990s pace. And financing in general remains a problem: “Mortgage lenders are still wary about extending credit,” says Koropeckyj. “The high share of homeowners with negative equity also constrains the housing market.”

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