Lurking in the Shadows

A spate of better-than-expected economic reports has spurred growing talk of a U.S. recovery. In fact, many observers are convinced that the post-crisis low is in, and that it’s onward and upward from here. One problem with this view, however, is that some of the data we are getting is not all that accurate, as I noted in “More of Less.” Perhaps more importantly, the headline statistics don’t  necessarily tell the whole story (as I alluded to in “Thinking Like a Bull”). This seems particularly true when it comes to getting an accurate read on supply-and-demand, which ultimately determines future economic trends. In at least four areas of the economy, there is a large overhang of prospective supply that can quickly come to market if things suddenly perk up. Such a dynamic tends to keep a lid on prices and turnover, nipping nascent recoveries in the bud. The following reports highlight four areas where growth-stumping supply lurks in the shadows:

Small Business

“Why Some Business Owners Think Now Is the Time to Sell” (New York Times)

There is a pent-up pipeline of owners who have had to put off selling in recent years because of the economy. And now that many of these companies have at least one year of profits on the books, they are more attractive to potential investors.

“A lot of these companies are having record profits because they reduced their overhead in the downturn and now sales are coming back,” said John D. Emory Jr., chief executive of Emory & Company, a Milwaukee-based investment banking company that specializes in selling businesses with $10 million to $100 million in annual revenue. “A lot of owners have told me they want to start a sale process in the first half of 2012, hoping to complete the sale before the end of 2012. Many owners, especially the leading edge of the baby boomers, wanted to sell in 2008, 2009 or 2010 and would have sold in those three years had the economy stayed strong.”

Those looking to sell are taking steps to appeal to buyers: trimming costs, diversifying revenue, upgrading financial statements and making the chief executive’s role less essential. And they are braced for the sales process to take longer than they would like.

Housing

“Shadow Report Shows Inventory Waiting” (Bradenton Herald)

MANATEE — The housing market may not be rebounding quite like recent sales numbers hint, according to a report released Wednesday that tracks hidden inventory.

A California-based real estate analytics company said there’s five months of pending supply across the country ready to hit the housing market that hasn’t been calculated into official inventories.

Most of those 1.6 million properties lurking in the shadows are homes where payments have been delinquent for more than 90 days but have not yet been seized by the banks or listed as short sales.

The numbers are cause for concern because once they see the light, they will likely further drag down area values with an oversaturation of under-priced distressed homes, the CoreLogic report shows

“This adds to the supply of unsold homes, which puts downward pressure on home prices,” CoreLogic Senior Economist Sam Khater said. “It also adds to the already high vacancy rate of homes, particularly in the hardest hit areas around the country.”

Labor

“Will the Real Jobs Number Please Stand Up?” (Robert Samuelson, Washington Post)

A lot is riding on the unemployment rate. Judged by political throw-weight, probably no economic statistic is more important in the next year. If it declines, people will feel better about the economy, bolstering President Obama’s reelection prospects. If it moves sideways or creeps up, Republicans will benefit. The jobless rate’s recent drop to 8.6 percent in November from 9 percent seems to give Obama a head start. But things are not as simple as they seem.

The news appears straightforward. The Bureau of Labor Statistics conducts two monthly surveys of the job market: one of households (they’re asked who’s working, who isn’t and who is looking for a job) and one of businesses (they’re asked how many people they employ). The unemployment rate is based on the household survey. It reported an increase in November of 278,000 people with jobs, pushing the unemployment rate down sharply.

But there’s a snag. If people stop searching for work, they’re not counted in the labor force or as unemployed even if they’d like a job. In November, some 487,000 people dropped out of the labor force, too discouraged — many analysts believe — to look for work. Adding these people to the officially unemployed would have produced a jobless rate of 8.9 percent instead of 8.6 percent, according to Heidi Shierholz of the Economic Policy Institute, a liberal think tank.

The payroll survey of businesses also raises doubts. It reported a jobs increase of 120,000 in November, less than half the employment gain of the household survey. And the increase was actually slightly below the monthly average for the previous year of 131,000. (There are often unexplained differences between the household and payroll surveys.)

Next year’s unemployment rate — and its political impact — will depend on two things: the strength of job creation, and the number of “discouraged” workers who leave or re-enter the labor force. The two will interact, sometimes strangely. Better employment prospects may spur more discouraged workers to look for a job. Perversely, this could raise the unemployment rate.

“If the job market improves, the labor force will grow faster,” says economist Gary Burtless of the Brookings Institution. “Some people who have dropped out will come back in.” Similarly, if job creation remains weak, more discouraged workers might stop looking for work. This could lower the unemployment rate.

One way or another, the effect could be large. Already, the poor economy has depressed the “labor force participation rate”: the share of those ages 16 and over in the labor market. Since 2007, it’s fallen from 66 percent to 64 percent. Though the decline may seem small, it represents about 4.8 million people. That’s in addition to the 13.3 million officially unemployed.

Burtless thinks that as many as 3.6 million of the 4.8 million people who have left the labor market might re-enter. But that’s a difficult estimate to make, as he notes, because there are three long-term trends that are also reducing labor-force participation.

First, as the population predictably ages, the share of working Americans already is inevitably declining. Second, the flood tide of married women into the workforce, while not dramatically reversing, has stopped. And, finally, some younger Americans (16-24) seem to be choosing to stay longer in high school, college and graduate school.

So the true state of unemployment is shrouded in a host of unknowns, except that everyone agrees that it’s too high. Is the rate’s recent drop real? Or will it turn out to be a statistical fluke? Could the unemployment rate give a misleading signal: rising if strong job growth lures more people into the labor market; falling if weak job growth causes more to quit looking and not be counted? These are all good questions with huge implications for the economy and politics in 2012. Stay tuned for the answers.

Commercial Real Estate

“Real Estate: Catch A Falling Knife” (The Daily Capitalist)

Continued improvement is a relative thing. In the market that I am familiar with, Los Angeles, CRE is still in the doldrums, tenants are hard to come by, and rents are not improving. Most of the improvements nationally are in A Class properties in large MSAs. In general, except for areas like NYC and Washington, D.C., rents aren’t improving that much and values remain depressed. That scenario is unlikely to change in 2012.

One thing driving this is debt. There is still a huge amount of CRE debt that needs to be refinanced—it doesn’t peak until 2013:

And delinquency rates are still high:

The good news is that this debt is being “processed” through the system and deleveraging is occurring, albeit very slowly. The government did much harm in the beginning of this crisis by not requiring banks to mark-to-market, thus dragging out the necessary deleveraging process (write-downs and foreclosures).

…

The bottom line on the CRE markets is that prices appear to be flattening, but there is a substantial refi problem continuing to overhang the markets. As the bulk of these loans need refinancing at their maturity dates, it is likely that many of them will not be able to replace their loans and will face the requirement to come up with additional capital or face foreclosure, thus delinquency rates will remain high, especially in the sub-Class A markets. This has been the story of CRE for the past four years and there are no economic dynamics that would change it.