As we begin the new year, we are sensing great positive momentum on the economic front. Unemployment is down, oil prices are down, and consumer sentiment is up. Nonetheless, questions abound as to what these numbers really mean. Where will all this economic activity take us in the coming year? Most importantly, what are the opportunities to look for as entrepreneurs?
Since our last update, interesting economic events occurred to change several previously held paradigms as to where we are headed. As we will see in this article, some of these new developments pose a challenge. They benefit some economies and industries, while posing serious concerns for others. One thing evident is that the U.S. economy improved significantly during this last quarter. However, the question still remains as to whether or not this improved economic environment will be sustainable, and to what extent it will permeate to all sectors of our country.
Let’s now take a look at what’s behind the recent numbers and developments…
Gross Domestic Product
The Consumer Department on Tuesday December 23, 2014, reported that the U.S. GDP expanded at a 5% annualized rate in the third quarter. Previous estimates had reported GDP to be closer to 3.9%. One main reason for this improvement is due in large part to the unexpected drop in oil prices.
Without question the falling oil prices will reshape the 2015 outlook for U.S. growth and inflation. The recent decline in gasoline prices at the pump will put an estimated $40 billion in American’s pockets in the fourth quarter. This equates roughly into $42 to $60 extra cash per person each month, based on the current population numbers in the U.S. On balance lower oil prices are positive, if spending doesn’t overheat causing inflationary pressures. As we will see below, the increase in personal wealth caused by the drop in oil will continue to be a significant factor to the U.S. economy.
In the first 11 months of 2014, the U.S. economy added 2.65 million jobs. Currently, the unemployment rate is now the lowest since the recession began at 5.8%. However, it is important to note that this number does not include all those Americans who are no longer looking for work. The traditional unemployment rate counts only those actively looking for work. Those who stop looking are not included and instead counted as labor force drop outs.
In December 2007, the month the recession started, 66% of the working age population either had a job or was actively looking for one. By September 2014, participation in the workforce had dropped to 62.7%; the lowest level since 1978. This drop in participation represents 11.5% of the population that are no longer participating in the workforce. Some of the drop out was expected due in part to the Baby Boomer generation turning 60 and retiring by the millions.
However, their impact is only a small percentage of the total drop out rate. The reason the participation rate is important is because it is directly related to the size of the workforce, which is a key determinant of how fast the economy can grow. A smaller workforce presents a drag on the economy both from a consumer consumption and government fiscal outlook. Two thirds of the U.S. GDP comes from consumer consumption, so fewer workers paying taxes affects the government fiscal outlook.
Despite more Americans being employed, wage growth continues to be stagnant. This puts a damper on the economy growing further. The average hourly earning for private sector workers rose 9 cents in November, a 0.4% increase from October, doubling the average monthly gains in the prior 12 months. Yet, this small increase is not enough to even offset the inflation rate. When compared with workers earnings in the early 1970’s, today’s workers have lost approximately 74% of their purchasing power. Amazingly this is true despite many workers working two and three jobs.
Adding to the stagnant wage growth is an additional constraining factor: the current trend of the majority of workers staying put in a job. This fact suggests that the labor market lost some of its luster, making it harder for people to enter the workforce and for younger workers to grow into senior and better paying jobs. Some of this lack of upper job mobility is also indicative of the slowdown and continued lack in the formation of new companies.
The Federal Reserve made it clear that they will begin to increase interest rates near the middle of 2015. When the rates actually are raised depends on what develops with regards to inflation. The drop in oil has a direct effect on the overall inflation rate in the U.S. For Example at $60/barrel, GDP is calculated to be 2.7%; with consumer spending contributing 3.0% and inflation projected to be 2.0%. Hypothetically, at $40/barrel, GDP is projected to rise to 3.1%; with consumer spending increasing to 3.4% and inflation dropping to 1.9%.
Now, it is expected that if the Central Bank puts more weight on the looming inflation drop, they will hold off on an interest rate increase. In contrast, should they put more weight on underlying commerce strength, they will proceed as planned. Also if they put more weight on underlying economic strength, they will proceed as planned. Any business considering to borrow for expansion and growth reasons is prudent to keep an eye on these developments and plan accordingly.
The University of Michigan Index of Consumer Sentiment rose to 93.4 in early December. The highest level in eight years. This growing optimism among consumers boded well for retailers during the holiday season. Both Costco and Wall Mart, as well as many restaurants, reported same store sales significantly improving these last two months when compared to the previous quarter.
Since our last update, Americans increased their borrowing with new mortgages, car loans, credit card purchases, and student loans. Auto lenders made $105 billion in new loans, the highest level in nearly a decade. Student loan outstanding rose $8 billion to $1.1 Trillion. Debt rose $78 billion between July and September to $4.7 Trillion. All these numbers suggest that Americans are gradually borrowing again after years of shedding debt. This increase in consumer confidence emboldens households to once again begin to use credit to supplement their cash flow. As we discussed above, the wage stagnation is a contributing factor here.
Default rates on mortgages and car loans declined, whereas loan delinquency on student loans rose from 10.7% to 11.1% in the third quarter. The student loan burden continues to be a major problem with younger Americans, especially the millennials. This group now features a -2% savings rate, which dampens any possibility of making large purchases such as buying a home.
Sales of previously owned homes tumbled to a six month low in November by 6.1% from a month earlier, the lowest level since May of 2014. Yet in the last month of 2014, contracts signed to buy previously owned homes rose to the third highest level since 2013. Meanwhile, sales of new homes essentially remained unchanged over the past year.
Interestingly earlier indicators hadn’t pointed to such a slump. For example, pending home sales declined just 1.1% in October and were flat in September. It was therefore expected that in general the housing market would see more robust activity and appreciation. Nonetheless, prices so far are holding up with the median sales price for existing homes up 5% from a year ago. As foreclosures fade, and investor purchases step back from the market, price gains have slowed and are holding at this level. Many economists believe that the 5% level of appreciation is the sweet spot where real estate wealth can increase without the market developing into a bubble.
U.S. domestic manufacturing appears to be doing well. The Institute for Supply Management’s Index of Manufacturing activity rose to 59 from 56.6 in September. There is some cautionary optimism, due in part to the stronger dollar making U.S. products less competitive globally.
Retail spending over Thanksgiving weekend fell 11% from a year earlier, according to the National Retail Federation. One reason cited for this decline may be due to the fact that retailers started offering deals days and even weeks before Thanksgiving. Nonetheless, shoppers spent an average of $380.95, down 6.4% from a year earlier.
The global economic outlook is grim as of the time of this article. China reported slowing economic growth, which contributed to the drop in prices of raw materials – including oil. As a result of sanctions and the price drop of oil, Russia appears to be on the verge of entering another recession. Meanwhile Europe continues to struggle due to a combination of low growth and low inflation, coupled with a high unemployment rate. Europe is currently reporting their GDP at only 1.3%. Purchase Indexes in China, South Korea, Germany, France and Italy showed manufacturing in these nations barely grew or contracted.
The Ever Increasing Strength of the Dollar
Currencies across the globe continue to rumble against the Dollar. On a positive note, the surging dollar and falling commodity prices are delivering a windfall to American shoppers. Unfortunately most commodities are priced in Dollars, so consumers and companies outside the U.S. see their buying power shrink when their currencies weaken.
At the same time, a stronger Dollar hurts U.S. exports by raising the production costs relative to foreign rivals, therefore cutting the value of overseas profits when converted into dollars. These are some of the issues cited by many multi-nationals, including IBM and McDonalds, as to why they are experiencing a major drop in revenue. As a result, the Institute for Supply Management at the beginning of December stated that its Manufacturing Purchasing Managers Index (a gauge of sentiment among purchasing executives) eased slightly to 58.7 in November from 59.0 in October.
Historically, readings above 50 indicate expansion. The index has remained in this positive territory for 18 consecutive months now. The question currently; will this decrease become a downward trend going forward? Overall, U.S. multi-nationals have hurt because of both the strengthening dollar and by the slowing European economy. Any business dealing internationally, and especially in Europe, will have to take into consideration these two critical aspects of the economy as they do business internationally.
What does this all mean?
As we see in this article, the overall economic outlook for the U.S appears to be positive. The momentum going forward is strong, holding much promise for a good economic year. The U.S. stock and bond market benefited greatly by this show of strength, as world wide investors move their funds to the safety of the American markets. Since two thirds of the American economy is based on consumer spending, increase in wages is a critical part of maintaining and growing this momentum.
Without wage inflation much of what is gained in GDP will dissipate. It is expected that in a more competitive job market we begin to see an upward pressure on wages. The primary dark economic clouds in the horizon come from overseas markets such as Russia, Japan, and Europe, as well as from various commodity based economies. To what extent their challenges will effect the U.S. over this next year is not known at this time.
For a small business, the increase in consumer confidence should translate to more sales as consumers continue to spend. Any business considering borrowing for expansion is wise to keep a firm eye on potential interest rate hikes and plan accordingly. Alternatively, it is expected that the Securities and Exchange Commission will finalize rules required by the Jumpstart Our Business Startup Act of 2012. This will allow businesses to raise small amounts of capital from investors through what is known equity crowd funding.
As the year progresses we will continue to track these developments. In the meantime, from all of us at Bay Area Mastermind, we wish you a prosperous New Year.
Explorations of the current business landscape often occur during meetings of the Bay Area Mastermind group. The intention is to provide business owners a chance to meet, collaborate and support each other as they face the day to day challenges of running a business. If you feel called to connect in this way with other entrepreneurs, then check out a “Test Drive” in the coming weeks.
Your business will thank you.
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