Real Estate Forum - September 2011

worth, versus 46% for stocks, mutual funds, and pension assets. As a result, the recent drop in stock prices could cut overall consumers spending by $140 billion, or 1.3%, during the next year, according to Paul Dales, U.S. economist at Capital Economics, and shave 0.5% off next year’s GDP growth.

One group of consumers particularly hard hit by declining equity prices and today’s low interest rates are those about to retire or who are retired. A recent study by the Center for Retirement Research at Boston College found that only 25% of people retiring had enough savings to maintain their standard of living, and the Employee Benefit Research Institute’s annual survey found that close to 30% of employees are not confident about having a comfortable retirement.

FRUGALITY AND DEBT REDUCTION The growing economic uncertainty is likely to reinforce the post-recession shift in consumer attitude toward frugality and debt reduction. Between 2001 and 2007, consumers doubled their household debt from $7 trillion to more than $14 trillion. The bursting of the housing bubble and subsequent “great” recession have forced consumers to begin the painful process of reducing their debt burden to more normal levels. Since 2007, consumers have reduced their debt from 130% of their disposable income to around 113%—still well above the 85% that economists believe is sustainable. Almost all of the debt reduction that has occurred during the past three years—$932 billion—came from mortgage and consumer debt defaults. While defaulting on mortgage debt and remaining in one’s house until foreclosure may provide consumers a burst of free cash flow, over the intermediate term it lowers credit scores and limits their ability to borrow and spend for years to come. The Fed recently reported that 41% of U.S. households can borrow less than $3,000 on their credit cards and 23% have been turned down for a credit card this year.

Given the bleak state of consumer finances and
lack of consumer confidence in the economic
recovery, consumers are acting like “zombies”
when it comes to spending, opting instead to
increase savings and reduce debt. Since consumer
spending accounts for two-thirds of the economy,
“zombie” consumers are likely to put a damper on
economic growth for several years, until their debt
burden is more manageable and their confidence
in the economy improves significantly.

MANUFACTURING, BUSINESS INVESTMENT AND EXPORTS DRIVE RECOVERY With the housing market in decline and consumers in a frugal state of mind, sustaining the recovery increasingly depends on the continued growth in manufacturing, business investment, and exports. Manufacturing, which has been the most consistent bright spot since the recovery began in 2009, slowed somewhat during the second quarter as supply problems stemming from Japan’s earthquake disrupted production, particularly in the auto industry. Output did recover in July as auto and parts production and parts jumped, increasing plant capacity utilization to 77.5%. Overall, manufacturing output was up 3.8% in July from one year prior. Contributing to the recovery in manufacturing has been the growth of exports from $125 billion in 2009 to $170 billion in 2011. During the first six months, exports were up 16 from one year ago, with 56% of the growth from emerging markets. Approximately 50% of U.S. exports are manufactured goods, which support approximately 4.0 million manufacturing jobs and another 3.0– 3. 5 million indirect support jobs in the transportation and service sectors.

The outlook for manufacturing during the second half of the year is clouded by regional Fed reports that manufacturing demand plummeted in August as well as uncertainties surrounding consumer spending and continued export growth in the face of slowing economic growth in Europe and several emerging countries, including China and India. Partially offsetting the effects of a global economic slowdown is the Fed’s stated policy of keeping interest rates near zero until at least 2013, which is keeping the value of the dollar weak and enhancing the competitiveness of U.S. exports. In addition, July’s durable goods orders rose 4%—the most in four months—after falling 1.3% in June, according to the U.S. Department of Commerce. These offsets may float manufacturing through its current rough patch and enable output to grow around 2.5% during the second half of the year.

Business investment in equipment and software has accounted for one-third, or 0.8%, of average GDP growth since 2009. That is four times the contribution after the 2001 recession, according to RBC Capital Markets. Business spending on equipment and