The Healing Process Has Begun

By Marshall J. Vest
Forecasting Project Director

June 1, 2010

Repair of the extensive damage to Arizona’s economy has begun.  An entire decade of growth has been lost, and it will take years to restore.  Let’s hope the new decade brings renewed prosperity for all.

Economic recovery at the national level is proceeding nicely.  After the 5.6% surge in 2009Q4, real GDP grew by 3.0% in the first quarter and could top 4% in the second.  For all of 2010, real GDP will grow by 3.5% or so.  A swing in inventories accounted for earlier growth but now exports and fiscal stimulus are providing needed lift.

The business environment continues to improve steadily.  After-tax non-financial corporate profits and cash flows are very strong and moving higher, and that’s boosting investment spending on equipment and software.  Credit conditions continue to improve, and inflation and interest rates remain low.  Consumer spending is growing at the fastest pace in three years.  Nonfarm employment is expanding much faster than expected.  Housing markets are stabilizing as well.

Arizona is lagging behind other parts of the country, but conditions are looking much better here too.  Consumer spending is increasing as evidenced by retail sales figures.  Nonfarm employment has stopped falling as hiring resumes, at least in some sectors.  Homebuilding activity has moved up off the bottom, and home prices are no longer declining.  Not all components of the economy have turned the corner and entered recovery mode, but the list is growing.

Recent Evidence

Retail sales statewide have been growing since July 2009.  Month-on-month growth, after adjusting for seasonality and expressed at annual rates, registers 8.8% over the past six months.  Four major subcategories have recorded double-digit gains.  Consumers are buying furniture once again (up 20.7%), thereby breathing life into a deeply depressed category.  They also have opened their wallets at clothing and accessory stores (up 11.3%) and “miscellaneous” retail stores (up 19.5%).  Even motor vehicle dealers, miscellaneous automotive, and building materials stores are registering positive growth.  Only general merchandise stores are still declining.  Food and liquor stores and restaurant & bar sales are flat (Exhibit 1).  

 

So, why are consumers boosting spending while surveys of consumer confidence continue to remain close to historic lows, with readings near 60 (Exhibit 2)? 

Consumers are still worried about possible job losses, the absence of raises during the past three years, and declines in net worth as the value of their homes plummet.   Nevertheless, they are moving to satisfy “pent-up demand” for items that were deferred during the recession.  Reports from nationwide retailers indicate resurgence in high-end cars, home improvements, and luxury items by upper-income households.  The increased spending is being covered by a decline in the savings rate, to 2.7% in March from 4% last year.  Federal rebate programs for energy-efficient appliances, replacement windows and doors, homebuyer credits, and new car purchases also have accelerated purchases.  Spending also is being fueled by delinquent homeowners who have extra money since they stopped making mortgage payments.  Many remain in their homes rent free for as long as two years before getting thrown out.  Those who are now renting have cut their housing costs in half or more, and that frees up cash for spending.

As job growth resumes and incomes start growing again, sales will benefit from a wider swath of households.  We’ve revised upward our forecast for retail sales statewide to nearly 6% growth this year, followed by an almost 11% gain the following.  Our forecast of a broader measure that includes restaurant & bar sales, gasoline sales, and an estimate of food sales is shown in Exhibit 3.   

Nonfarm jobs, a comprehensive measure of employment, hit bottom in November 2009.  Seasonally adjusted,employment now rests a little below 2.4 million, down 294,400 from its August 2007 peak. Since bottoming four months ago (data through March),employment has grown by 8,200 jobs.  That’s not much, but it’s a beginning -- and the direction is encouraging (Exhibit 4). 

Not all employment sectors have stabilized.  But in the last three months, we’ve seen improvement or reversals in several sectors.  Construction’s devastating plunge came to a halt as did other durable manufacturing.  Employment in food and drinking places, building materials, accommodations, wholesale trade, clothing, and non-durable manufacturing have all reversed direction and are now headed upward.  These sectors join mining, educational services, wholesale trade, and health care and social services that have been increasing for some time.

Aerospace manufacturing and federal government, both of which had been growing rapidly, leveled off during the past three months.  Other sectors that continued to show stability include professional and business services,employment services, and transportation and warehousing.

Fabricated metals manufacturing, computer manufacturing, financial services, information, furniture stores, educational services, motor vehicle dealers, and state and local government payrolls continued to move lower.

From the fourth quarter 2009 through the end of this year, the most net new jobs (10,000) will beprovided by educational and health services.  All other major sectors will add smaller amounts with the exception ofconstruction, government, and professional and business services.  By the end of 2011 (again comparing to fourth quarter 2009), the numbers of new jobs increase dramatically, especially in the aggregate category covering trade, transportation and utilities.  Construction and government payrolls will continue to suffer and be a drag on economic growth. 

Arizona’s unemployment rate moved upward in February and March, reaching 9.6% before dropping back to 9.5% in April.  The explanation as to why unemployment moves up in the early stages of a recovery is that the labor force grows more rapidly than employment.  The labor force rises faster because workers who had stopped looking for work (and dropped out of the labor force) reenter when they learn that jobs are once again being created.  Meanwhile, the number of initial claims for unemployment insurance continues to come down rather dramatically.  We expect the unemployment rate to approach 6.5% by the end of next year.  Exhibit 5 shows this widening gap, which will persist for a few more months.

Population counts from the 2010 Census should be available next March.  If current estimates are accurate, Arizona will have nearly 6.7 million residents.  That should rank Arizona as the 13th largest state.  Metro Phoenix will account for 4.45 million, while metro Tucson records 1.03 million.  Our forecasts show that statewide, population will swell by 84,000 this year and by 131,000 next. ( Find links to detailed economic forecasts for Arizona, Phoenix-Mesa-Scottsdale, and Tucson metros, through link in the RHS sidebar above.)

Fourth quarter data for personal income showed an annual rate of gain equal to 4.5%.  That reverses a string of losses and is the strongest increase since the third quarter of 2007, before the recession began.  Annual gains of 1.9% and 4.2% are forecast for this year and next.

Housing markets in Arizona appear to have bottomed, but recovery is still a ways down the road.  Affordability stands at record highs and mortgage rates have dropped below the psychological threshhold of 5% once again.  But the supply of vacant homes remains extremely high.  Nationwide, vacancy is at 2.5% compared to a normal 1% or so.  Measures for Arizona are not available, but vacancies are no doubt higher.  The number of vacant units reported by the US Postal Service approaches 120,000 statwide, of which 82,000 are in metro Phoenix and 25,000 are in metro Tucson.

Residential building permits are leveling off now that homebuyer credits have ended, and are expected to remain stable until excess inventory is absorbed.  Foreclosures appear to have leveled off nationwide, but remain near record high levels.  Repossessions are at record highs and continue growing at rapid rates,as lenders continue to work through their backlog of delinquent properties.  According to some estimates, one in four homeowners nationwide is underwater.  It’s closer to half in Arizona.  That will continue to restrain upward movement in housing prices.  Nevertheless, home prices are increasing.

Using realtor data, the median price of homes sold in Phoenix was 9.1% higher in the first quarter than a year earlier, which ranks 31st among 152 metro areas.  This corraborates the Home Price Index published by Standard and Poor’s Case-Shiller that shows metro Phoenix home prices growing at a 17% annual rate since the middle of last year.

Multifamily markets continue to swoon as vacancy rates continue to rise and rents fall.  Accoding to industry sources, apartment vacancies are a record high 8.0% nationwide and 13.3% in metro Tucson.  Rental rates fell 2.9% nationwide and 1.3% in metro Tucson during the past year.  Apartment development is practically zero and will remain moribund until the “shadow market” comprised of vacant houses for rent subsides.

In commercial markets, it’s much the same story; vacancies continue to rise and lease rates are declining.  No new construction is expected for at least another year.

The Outlook, With Risks

Not all sectors have turned the corner and for some, recession will linger a bit longer.  But a growing portion of the economy has begun to recover, and momentum will continue to gain in coming months.  Oil Spills, Eurozone turmoil, and volatility in stock markets won’t derail the recovery.

Closer to home, it’s still too early to gage damage from the state’s controversial new immigration law.  Estimates from credible sources within Arizona’s tourism industry say that cancellations of meetings and conventions approached two dozen as of mid May.  Add to that the effects of boycotts by other states and cities.  The effects will not be enough to derail the state’s recovery, but will hinder the healing process.  Interestingly, a recent survey by Phoenix-based Behavior Research Center found that the majority of Arizonans favor the new law – 52% in favor versus 39% opposed.  National polls have found similar results.  It’s possible that Arizona’s image may receive a lift from this controversy.  Other states reportedly are looking at similar legislation.

Finally, as this is written, results from the May 18 special election are in and voters overwhelmingly approved a one cent increase in the state sales tax rate by a two-to-one margin.  This will raise a little less than $1 billion annually over three years.  Voters displayed great recognition of the dire situation of state government finances and the inability of elected officials to remedy the situation on their own.

Unfortunately, the extra sales tax money does not fix the problem.  It’s but one piece.  In the fall, voters will be asked to allow the legislature to use funds dedicated for early childhood development and for land preservation.  That won’t be enough, so large cuts in spending are yet to come.  There is still a $2.2 billion structural deficit remaining, and growth in revenues as the economy recovers won’t close the gap.  Stay tuned…

 

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For additional information, please contact the Economic and Business Research Center.