2007 Quick Economic Review and 2008 Outlook - Here we go!
2007 overall was an average economic year, but the outlook for 2008 is starting to look like a recession is possible. The Federal Reserve is signaling aggressive actions will be taken to prevent recession.
- Home sales and market indexes turned negative in 2006 and continued in 2007. The sub-prime market collapsed when home prices started to fall and interest rates began to go up, resulting in many of these homeowners unable to afford the variable monthly payments. Borrowers then faced stricter loan standards and mortgage applications for homes decreased. Banks have reported billions of dollars in losses as payment delinquencies and home foreclosures have increased. The Mortgage Bankers Association reported in December the “delinquency rate for mortgage loans on one-to-four-unit residential properties stood at 5.59% of all loans outstanding in the third quarter of 2007 up 47 basis points from the second quarter of 2007, and up 92 basis points from one year ago… The percentage of loans in the foreclosure process was 1.69% of all loans outstanding at the end of the third quarter, an increase of 29 basis points from the second quarter of 2007 and 64 basis points from one year ago… subprime Adjustable Rate Mortgages (ARMs) only represent 6.8% of the loans outstanding, (but) they represent 43% of the foreclosures started during the third quarter.” More banks began tightening credit standards in April. Citigroup wrote-off $18.1 billion on bad mortgage loans in the fourth quarter 2007; resulting in a loss more than double what was expected, and the need for a capital (liquidity) investment of $12.5 billion. Other banks have experienced similar write-offs and losses.
- The National Association of Realtors reported November existing home sales rose 0.4% for an annual rate of 5 million - the first reported rise in nine months. However, these sales are still 20% below the year ago level. U.S. median home prices fell for 10 consecutive months, declining a record 6.7%.
- Retail inflation increased at a 4.1% annual rate as of November due to the significant increase in energy and food costs. Without these two factors (which tend to be more volatile), the underlying inflation rate was 2.5% for 2007, a low rate within targets. But this time, the higher energy prices are likely to stay with us for a long time, increasing the potential negative economic impact. See my article on the long term trends in oil prices.
- Consumer debt payment levels remain at an all time high at 14.3% of disposable income. The increase in percent of income used to pay debt started in the early 1990’s to today’s all-time high.
- Productivity growth in the economy has rebounded from only 1.0% in all of 2006 to 0.7% in 1Q07, 2.2% in 2Q07, and then a strong 6.3% in 3Q07. Productivity growth is a key driver for improvements in our standard of living as it is the pre-cursor to corporate profits and income gains.
- Capacity utilization has remained steady for the year at a healthy 82%, though down slightly in the most recent 2 months (defined as the ratio of industrial production to manufacturing capacity - or the greatest level of output that a plant can maintain within the framework of a realistic work schedule).
- The unemployment rate has remained relatively low at 4.7% (compared to 4.6% last year and 5.8% average over the last 50 years) on average for the year. But December 2007 unemployment came in at 5%.
- Since 1980, corporate profits have averaged 7% of Gross Domestic Profit, and were 10% in 2006. In 2007, corporate profits are expected to be about 11% of GDP. But earnings appear to be softening at many companies. Some indicators include:
- UPS, the delivery company, reported 4th quarter volumes were slower due to slower retail sales.
- The US Commerce Department reported that retail sales in December (the holiday season) actually decreased 0.4% from the prior year.
- Wal-Mart reported their 48 week comparable same store sales grew a mere 1%, down from 1.9% a year ago.
- American Express reported that the slow-down in consumer spending and an increase in credit card delinquencies will likely reduce their profits in 2008.
- And Boeing announced a further delay in the 787 Dreamliner deliveries, resulting in the high probability that the plane will not make its first flight until June 2008, thus reducing expected revenues.
Since 2003, the US dollar has weakened about 30% relative to the Euro and other currencies. Currency prices reflect the balance of supply and demand for currencies, market psychology (fear), and economic conditions. The Wall Street Journal reported “America’s most important trading partners have expressed angst over the dollar’s decline. The president of the European Central Bank (ECB), Jean Claude Trichet, has expressed concern about the ‘brutal’ movements in the dollar-euro exchange rate. Japan’s new Prime Minister, Yasuo Fukuda, has worried in public about the rising yen pushing Japan back into deflation. The surge in the Canadian ‘petro dollar’ is upsetting manufacturers in Ontario and Quebec. OPEC is studying the possibility of invoicing oil in something other than the dollar. And China’s premier, Wen Jiabao, recently complained that the falling dollar was inflicting big losses on the massive credits China has extended to the U.S.” Thus the need for a “joint intervention” to prevent the dollar from declining too far.
On January 10, 2008, Ben Bernanke, Chairman of the Federal Reserve stated “Since late last summer, the financial markets in the United States and in a number of other industrialized countries have been under considerable strain. The turmoil has affected the prospects for the broader economy, principally through its effects on the availability and terms of credit to households and businesses.” The Federal Reserve is expected to again lower interest rates in January.
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