Rising employment, a healthier housing market and a willingness by larger corporations to invest in infrastructure should add some needed oomph to the business environment
Blue skies and cool breezes–that’s the economic forecast as the calendar turns to a new year. Businesses looking to bolster revenues and profits over the next 12 months should benefit from a gradual improvement in such vital supports as employment, housing and capital investment by big corporate players.
“Recent economic data have been encouraging,” says Sophia Koropeckyj, managing director of industry economics for Moody’s Analytics, a research firm based in West Chester, Pennsylvania. “Stronger job growth, record low debt service burdens, record high stock values and rebounding house prices are supporting consumer spending.”
While such factors would normally be expected to provide a healthy tailwind to the economy, a number of issues will continue to put a drag on progress. “Weak wage growth and a considerable amount of lingering slack in the labor market are preventing even stronger spending,” Koropeckyj says. She points to the high share of workers who would prefer to be employed full time but who must settle for part-time jobs.
The brighter 2015 outlook shows up in the number most commonly used to assess the state of the economy: gross domestic product. That figure represents the nation’s total revenues for all goods and services. The higher the number, the more likely business owners will find customers receptive to their marketing.
In 2015 the nation’s GDP is expected to increase at a 3.5% rate, according to Moody’s. That’s a considerable improvement over the economy’s average growth mode of 2.5%. “We are upbeat,” says Scott Hoyt, senior director of consumer economics for Moody’s. “It looks like the economy is starting to accelerate, and we expect that trend to be maintained.”
Business owners could be forgiven for harboring some doubts. After all, a year ago economists were predicting a much brighter 2014 than what was actually experienced. Indeed, that year’s 2.2% GDP growth rate was considerably below the 3.1% increased forecast by Moody’s. What happened?
|The International Sleep Products Association recently released its revised forecast for the U.S. mattress industry through December 2016 (paywall).
“The year started on a weak note caused by the severe winter weather and excessive inventory accumulation,” Koropeckyj says. Those issues pulled down the results for the remainder of the year.
Things weren’t helped by an unexpected summer spike in interest rates (sparked by some misinterpreted comments from the Federal Reserve about the end of quantitative easing), which put a damper on the recovery in the housing markets—not only in terms of direct sales but also in employment. “Fewer than anticipated construction jobs affected overall income growth in the economy,” Hoyt says.
Back in the game
Consumer confidence is a critical factor in a robust economy. When people buy more, that helps spur business activity in all sectors. And the public, it seems, is feeling more chipper than a year ago.
“Consumer confidence has been sort of ‘inching up,’ ” Hoyt says. “It has not risen a lot, but we are, by most measures, near post-recession highs. As conditions continue to improve and 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.”
Indeed, the jobs picture has been improving steadily. The unemployment rate had improved to a 5.9% level toward the end of 2014, and Moody’s expects it to decline to 5.7% by the end of 2015. By the end of 2016 the nation should experience what economists call “full employment,” which is an unemployment rate of 5.5%.
Given the improving employment picture, consumers are expected to open their wallets wider over the coming year. “Core retail sales should increase 6% in 2015,” Hoyt says. (Core retail sales exclude volatile revenues from auto sales and gas stations.) “That’s a significant increase from the 3.9% rate expected to be recorded when 2014 numbers are finally tallied.” It also reflects a more robust retail environment than the period just prior to the 2008 financial crisis when the comparable figure was only 4.6%.
Why the big spike? “Part of the reason is that 2014 has been stronger than the reported 3.9% retail growth rate suggests,” Hoyt says. “The weak first quarter in 2014 artificially depressed the year’s results.”
In other words, consumers are returning to the stores, and retailers are entering 2015 on a pretty good trajectory. “With employment growth what it is, income growth should tick up,” Hoyt says. “Construction also should 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.”
Housing is a big driver of jobs and of the economy—and businesses will be looking for a rebound in housing to help bolster 2015. Some improvement is indeed forecast: Housing starts are expected to ramp up to 1.5 million units in 2015, after coming in at the 1.1 million unit mark in 2014. While those numbers represent a gradual improvement over the results of recent years, they are still below what’s needed for a complete economic rebound. Koropeckyj points out that housing starts averaged 1.7 million units prior to the boom years of the middle of the last decade and peaked at 2.1 million units in 2005.
“There are many constraints on homebuilders’ willingness and ability to ramp up quickly,” Koropeckyj says. “These include the availability of construction and land-development loans, labor shortages and a lack of manufacturing capacity for certain building materials.” As a result of these capacity constraints, Koropeckyj says, the pace of housing starts could fall short of expectations for 2015.
As for sales of existing homes? “They have been slow to ramp up because credit availability remains very restrictive,” Koropeckyj says. The current 4.5 million annual sales rate is somewhat less than favorable—indeed, it is at a level last seen as far back as 2000.
For the economy to continue its long steady climb back from the 2008 recession, large corporations will have to play a key role—not only in hiring but also in investment. And here the environment seems most favorable. “Business confidence surveys generally reflect that firms see better times ahead,” Koropeckyj says. Corporate profits are expected to increase by 12% in 2015, following an actual decline of 0.4% in 2014 caused by an extremely weak first quarter.
While corporations, like consumers, have been reluctant to spend on investment and hiring, they are poised for growth in both areas, according to Koropeckyj. A number of factors suggest that they will invest more heavily in infrastructure and expansion over the coming 12 months. “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,” Koropeckyj says.
It all points to more spending, which can enliven the nation’s economic picture. “Real investment spending growth is expected to pick up from 4.9% in 2013 and 5.8% in 2014 to 8.6% in 2015,” Koropeckyj says. As for hiring: “Job opening rates have surged in recent months, at times as high as those during the best times of the last business cycle.”
What’s true for large corporations seems to hold as well for their smaller siblings. “At smaller companies growth has been slow but steady,” says Walter Simson, principal of Chatham, New Jersey-based Ventor Consulting. “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.”
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,” Koropeckyj says. “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.”
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, Pennsylvania-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.” (See related story on page 42.)
Unanticipated events may affect the economic forecast. Interest rates, for example, may rise after the Federal Reserve has kept them low for many years to help spur the economy.
In the best of worlds, that actually might stimulate the economy. “There might be an advantage to the Fed’s letting interest rates rise or at least to signaling they might move that direction,” Simson says. “It might incite the animal spirits of consumers who jump to get new homes in the belief interest rates would go up.”
More home buying could only be to the good—and not only because it leads to more construction activity. “After people buy homes they buy furniture, pools and spas, floor coverings and patios,” Simson says. “That goes on for two or three years after the house is purchased.”
Of course, too high of a spike in interest rates would have a negative effect on housing. “The biggest threat to the outlook would be a repeat of what went wrong in 2014,” Hoyt says. “That would be if housing markets do not gather momentum, and we do not get the anticipated construction and jobs.”
More risks abound. Consider another meltdown in the financial sector: “I am not convinced that the banking system is any better today than in 2008,” Simson says. “That could be a danger.” Yet the biggest risk, Simson says, might be that one of the world’s many severe problems—the Middle East, terrorist activity, the softening economy in Europe or the spread of Ebola—might blow up and create the next economic disruption.
“It’s a dangerous world,” Simson says. “The risk is that something bad happens that makes people stay home and watch TV rather than go off and do business. You have to wake up every day and pray that does not happen.”
In the early months of 2015, you can get a bead on where the economy is heading by watching for some key statistics in labor and housing. “Among the most important trends to watch will be how much labor-market slack is absorbed and how quickly,” Koropeckyj says. “Will the labor market tighten? And will that affect wages in a way that encourages consumers to open their wallets at retail stores?” A second factor is the willingness of banks to lend. “Improved mortgage-credit availability will be the key in enabling the housing market to take off.”
And keep an eye on the employment numbers. “People will be looking for continued job growth in early 2015,” Simson says. “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.”
What is the prospect for manufacturing?
Revenues are increasing. Backlogs are recovering. That’s the good news from the nation’s manufacturing base, as this forecast suggests.
What concerns do manufacturers have now? Here are some comments from Tom Palisin, executive director of the Manufacturers’ Association, a York, Pennsylvania-based regional employers’ organization with more than 350 member companies.
What are the areas of most concern for manufacturers?
Palisin: “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, companies are less able to increase production capacity, take on new orders or seek out new customers and markets. Apprenticeship programs and vocational/technical education that historically created the feeder pipeline that supported these skilled positions have withered over the last several decades and currently do not have the capacity to meet the current and near-term workforce demand.
“The forecast for the skill gap is that it will continue to hinder expansion—the Manufacturing Outlook Survey from the Philadelphia Federal Reserve has reported historic highs in hiring forecasts, and the state of Pennsylvania’s Center for Advanced Manufacturing Careers estimates another 20,000 skilled positions are required to meet the industry demand over the next 5 to 10 years.”
Has there been any improvement in the availability of capital?
Palisin: “Rates have remained historically low, making borrowing affordable for the manufacturing sector. Access to capital seems to be less of a concern for manufacturers seeking investment for expansion and growth. As a result of the recession and slow-growth period after, many companies had built cash reserves to stabilize their finances. That resulted in many companies refraining from commercial borrowing and instead using their retained earnings to invest.
“This trend will continue, but as these retained earnings are depleted, 2015 should see an increase in commercial lending by manufacturers. A particular focus of manufacturers’ investments has been on investing to improve productivity, which would include modernizing equipment as well as automation and information technology. The cost of automation has been dramatically decreasing as the cost for technology has been driven down in recent years.”
Are companies starting to build more products in the United States?
Palisin: “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.
“Areas of concern in this forecast are export markets, especially the European Union, where recent growth has slowed and the U.S. dollar has been appreciating—thus increasing the cost of U.S. goods in Europe, a key export market. It also remains to be seen how the current and planned reductions in defense spending will impact the U.S. manufacturing sector. Many defense contractors and suppliers already have felt the impact in a drop of sales and new orders.”