Posted on Wednesday, 4th January 2012 by Robert Domini

Happy New Year

 

The Wall Street Journal trumpeted the good news. The Dow Jones is up 6% for the year. The S & P 500 came in dead even, same as it ended last year. Not that I’m any expert, but the Fed has been on an expansionary policy of unprecedented proportions. We’ve had QE1,  QE2 sprees of print money. And there are those who are saying that our U.S.A. Fed is spreading money around the globe to the tune of $24 trillion. That’s funny money, of course. The U.S. credit rating has been downgraded and our Government refuses to even consider bringing spending under control. The second half of the year was marked by incredible volatility.  The average swing on a daily basis during October and November was 270 points. There were some clear winners. If you held 30-year Government bonds you made 35%. Those holding McDonald’s stock earned 31%. Everyone, and I mean everyone says that a major problem during 2011 was the squabbling of Congress over the budget. Would they rather the Republican House had just rolled over and played dead? Some of us would have wanted them to go to the wall and not give in when they were having their debt-ceiling battle. The end result of all the fighting was a very meager “cut”, which wasn’t a cut at all. This will be illustrated later in this newsletter. All things considered, we weathered 2011 a lot better than many of us thought we would. If you predicted volatility, you were right on target.

Just recently, we received some wonderful news. The unemployment rate had fallen to 8.6%, a 2 ½-year low. This was a big headline in the Toledo Blade. The Blade said it was seen as welcome relief. Private-sector employers added 140,000 jobs, but the Government shed 20,000 jobs during the same period. I thought that employment growth at this rate was insufficient to reduce the overall unemployment rate. Then way down on page 2, after Mark Zandi of Moody’s Analytics bestowed his blessing, it was surreptitiously reported that 315,000 unemployed workers had stopped applying for jobs in November. What a shame, you decide to take a holiday breather from your arduous and depressing ordeal of applying for jobs, and they decide to drop you from the rolls of the unemployed. Doesn’t seem fair, does it?

Way down on page 2, the real truth came out. Having given the President his election-season headline boost, it’s time for truth telling. “Serious concerns remain about the economy’s ability to weather the financial and economic turmoil from abroad.”   “The public sector continues to shed workers.”   “Excluding hundreds of thousands who have left the labor force, the country has a backlog of more than 13 million unemployed workers, whose average period of unemployment is at an all-time high of 40.9 weeks.”   Doesn’t sound that much like good news does it?

At the same time, however, we are beginning to see glimmers of an improving jobs market. Initial claims for unemployment insurance fell by 19,000 to 366,000. This figure has stood stubbornly at 400,000 or higher for many months. Small business added workers in November after shedding jobs for five consecutive months.

From The Appraisal Institute Economic Seminar, Columbus, Ohio

  • Interest rates are the lowest of the post-WWII period.
  • Monetary policy is expansionary.
  • Inflation is low.
  • Uncertainty is high.
  • Export growth is good.
  • Business spending is solid.
  • Inventories are low.
  • Ohio has had a “v-shaped” recovery.
  • The price of energy is going up.
  • State and local finances are going down.

Honeywell CEO Speaks Up

The chairman and CEO of Honeywell, David Cote, told CNBC that major corporations are hoarding cash due to economic uncertainty. He said that regulation is proliferating while the overhanging national debt is holding down business investment. Cote ventured that if we could begin to get control of our Federal Government debt, the economy would take off like a rocket.

George Mokrzam, Huntington Chief Economist and Bob Bach, Chief Economist for Grubb & Ellis

………reported that Japan is getting back to business. The earthquake seriously disrupted the supply chain. George said that our GDP has now recovered to its pre-recession level. That’s called recovery. The next stage is expansion which is a lot tougher. GDP growth is expected to be slow, at a rate of 1.5% to 2% per year. There is a ton of liquidity in the marketplace right now. Bank reserves are high, which is a good thing considering the threat of a meltdown in Europe. Money supply growth is beginning to accelerate. Capital goods orders are up and consumers are spending. However, housing is flat. Disposable income is rising somewhat and affordability is historically high. Again, corporations are sitting on a ton of cash.

Bach told us that long-term rates can be expected to rise along with economic growth. The U.S. is suffering from a hangover from QE 1-2, aka printing of money. This will cause inflation. The rate on a ten-year Treasury is way down, but can be expected to rise along with inflation. So, overall, job growth can be expected to just keep pace with the labor force, leaving the unemployment rate flat at least for the next twelve months. Most of our job growth will be in health care and the Federal Government. Construction will remain very slow. A major plus is that the freight business is way up.

Other Year-End Economic News from John Kasarda and Kurt Rankin, PNC

In terms of cash in the hands of American corporations, they are sitting on $2.1 trillion while Japanese firms have amassed $2.7 trillion. Corporate balance sheets are very good. Corporations can afford to pay high dividends if they choose to do so. Stock values, however, are pessimistic. Stocks are trading at a 10 PE ratio while the rate was more like 20 at the beginning of 2010.

There will be no double-dip recession, but we can expect slow growth. It will be a half-speed recovery. Europe is a risk to the U.S. economy, but it is not what’s holding back the U.S. economy. Looking back to the last three recessions, after one year the economy had recovered what it had lost. This time around we are just now getting back after four years.

People feel 81% confident about their own economic health, but feel about 40% confident about the U.S. prospects. Consumers have a very negative attitude about the U.S. economy. Consumer sentiment is down, although the savings rate is up and so is unemployment since 2008. Consumers have been hit with a lowering of their disposable income. In all, Toledo has lost 15% of home values and 10% of its jobs. The U.S. has lost 5% of its jobs and 30% of home values.

Business lending is picking up just at the right time. Business is interested in borrowing right now in order to expand. Productivity growth is slowing, and as productivity slows, firms begin to hire. In the 3rd Quarter, the GDP improved. As a result, employment can be expected to ramp up.

What are the Prospects for Commercial Real Estate?

Commercial real estate prices increased 2.2% in October. This is the first increase since the CRE recession began in 2008. The reason is that investment-grade property has made a strong recovery and the overhang of distressed properties and foreclosures has declined. Of course, investment grade properties are the newer buildings in good locations. For the rest of the market, the performance has not been quite as stellar.

Reports are that the lodging industry has turned in a strong performance this past year. Again, the best performance has been in the upper-tier properties. They call these the luxury and the up-scale properties. Occupancies in these segments are topping 70%. Conversely, occupancies in the lower-tier segments will lag behind. The same holds true for markets. The top-tier cities are performing strongly while the opposite is true of lower-tier cities.

Meanwhile, investor sentiment remains at a very high level. The index is at 152 which is the highest level since 2004, other than the second quarter when it reached 164. This is despite headwinds such as the European debt crisis, Washington’s inability to get control of the budget and the downgrade of the U.S. credit rating. Still, jobs actually grew in August, September and October at a 241,000 jobs per month pace. Retail sales beat expectations with a year-over-year increase of 6.1%. Many, if not most, investors are extremely wary of micro and macro economic circumstances. They clearly see a great deal of risk in the economy, primarily due to the incredible mounting debt both in the U.S. and abroad.

In real estate, apartments are a safe haven. 45% of real estate investors believe the CRE values have not yet hit bottom, but apartments are another story.  Vacancy rates have fallen to 5.6% while rents have risen 2.4% to an average of $975 per month. Most apartment investors believe that now is the time to buy.

What’s in the News as the Year Comes to a Close?

According to the WSJ, Christmas came early for the U.S. steel industry. Rising sales of cars, farm gear and oil-drilling equipment are boosting the demand for U.S. steel. Prices are rising amidst increasing production which is a welcome change from earlier this year when demand for domestic steel was weak. There is good news near NW Ohio. Gerdau SA, Monroe, Michigan, will invest $67 million to expand production. They make steel for the aero-space and defense industries. Russian steelmaker, OAO Severstall doubled the size of their Columbus, Mississippi plant last month to the tune of $550 million adding 1.7 million tons to annual production. AK Steel with plants in Ohio is raising prices on benchmark hot and cold rolled steel used by the auto industry. Steel prices are up 25% since November 2. Hot rolled steel is now selling for $750 a ton compared to $600 previously. Total shipments by U.S. steel plants were 76.4 million tons the first ten months compared to 69.7 million tons over the same period in 2010. This year U.S. auto makers are expected to churn out 13.4 million vehicles as compared to 10.4 million in 2009. All of this is very good news if it continues, especially for NW Ohio. In fact, GM Transmission in Toledo just announced 150 new jobs at their Jackman Road plant. It’s been a long, long time since we’ve heard that kind of news.

Baseline Budgeting

For at least the last 20 years the Federal Government, aka the U.S. Congress and the President have engaged in a fiasco called baseline budgeting. This is a slight of hand trick wherein each and every Federal department is budgeted to increase about 10% per year no matter what. Let’s say that the Department of Education or the Department of Agriculture or Transportation is slated for a 10% increase and the politicians are calling for a 4% cut in the Transportation budget. The other party then screams bloody murder for the “cruel” , “brutal” cuts. No one argues that this is not actually a cut at all. Neither the politicians, nor the CBO will admit to the ruse. It’s like a giant conspiracy with everyone acting like they believe the cuts are real. The truth is that the horrible, draconian cut was actually a 6% increase. The last time the Congress decided to make a cut in the budget it amounted to $38,500,000,000, which sounds like a lot of money, but with baseline budgeting it wasn’t a cut at all. The budget was scheduled to increase and everyone knew it. We all know that Social Security and Medicare are going up like crazy every year, especially now that the baby boomers are reaching retirement age in large numbers. Ask yourself why the Department of Transportation or Education go up 10% every year when the states run these two sectors lock, stock and barrel. The Department of Transportation builds no roads and the Department of Education runs no schools. The figures below will illustrate:

Why the U.S. was downgraded:

  • U.S. tax revenue: $2,170,000,000,000
  • Federal budget: $3,820,000,000,000
  • New debt: $1,650,000,000,000
  • National debt: $14,271,000,000,000
  • Recent budget cuts: $38,500,000,000

Let’s now remove 8 zeroes and pretend it’s a household budget:

  • Annual family income: $21,700
  • Money the family spent: $38,200
  • New debt on the credit card: $16,500
  • Outstanding balance on the credit card: $142,710
  • Total budget cuts: $385

But remember, the family is budgeted to spend $3,820 more next year no matter what, so a cut of $385 only puts a very small dent in what they will actually spend. They will actually spend $41,635 next year and go into the hole $19,935. Their debt will be almost equal to their income next year. Pretty soon, you’ve got to figure that the credit card company will get tired of loaning them money, right?? Another way of putting it, “a trillion here and a trillion there, pretty soon, you’re talking real money”.

Were TARP and the Auto Bailouts a Success or a Failure?

Conventional conservative wisdom is that both of these programs were unqualified failures. In fact, in conservative circles, if you were in

favor of these programs you were the object of scorn and derision. Let’s take a look at the postmortems. TARP was a 2008 program where billions were loaned to banks whether they wanted it or not. More than 99% of the federal funds loaned out have been paid back. The Federal Government has recouped more than $244 billion of the $245 billion it loaned to these banks. In fact, the Government is expecting to make at least a $20 billion profit on the deal. Ohio’s own Fifth Third Bank has paid back $3.4 billion, the entire amount borrowed.

As to the auto bailouts, approximately one-half of the amount loaned has been paid back. The Government is expecting to lose about $14 billion on the deal eventually. It is also fair to say that many, many jobs were saved by the bailouts. Some estimates on jobs saved are as high as one million. Speaking on behalf of the Toledo Metro economy, I must say that were it not for the auto bailouts I hate to think what kind of shape we would be in here in Toledo. Would we be expecting 150 new jobs at the Jackman Transmission Plant? Would we be talking about a Jeep expansion on Willys Parkway? I think not.

This Report Has Been Brought to You by:

Robert D. Domini, MBA, MAI

Ohio Certified Appraiser, also Certified in MI and FL

We are a full-service real estate appraisal firm. Give us a call next time you need a real estate, equipment or a business appraisal. Remember we do appraisals for eminent domain takings and tax appeals.

Have a Wonderful Holiday Season, Happy Hanukah, Merry Christmas and a Happy New Year!!

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