bizzXceleration: Performance, Value and Profit

Outlook 

Why It’s Worse Than You Think But this downturn is likely to last longer than the eight-month-long recession of 2001. While the U.S. financial system processes popped stock bubbles quickly, it has always taken longer to hack through the overhang of bad debt. The head winds that drove the economy into this dead calm— a housing and credit crisis, and rising energy and food prices—have strengthened rather than let up in recent months. To aggravate matters, the twin crises that dominate the financial news—a credit crunch and the global commodity boom—are blunting the stimulus efforts. As a result, the consumer-driven economy may not bounce back as rapidly as it did in the fraught months after 9/11. As it seeks to regain its footing in the second half, the U.S. economy faces two significant obstacles, neither of which was evident in 2001. The first is entirely homegrown: the self-inflicted wounds of the promiscuous extension and abuse of credit in the housing and financial sectors. The second is a global phenomenon that has comparatively little to do with American behavior: rampant inflation in commodities such as oil, food, and steel. These trends have conspired to inflict genuine economic pain and deflate consumer confidence. The Conference Board's Consumer Confidence Index in May slumped to a 16-year low. Fed: Economy 'generally weak', Fed official tough on inflation, More financial peril ahead

• Roubini on Retail Sales and Recession  

OECD Again Cuts U.S. Outlook The OECD's acting chief economist urged the Fed and the ECB to leave rates on hold for the rest of the year. The U.S. Federal Reserve and the European Central Bank should leave their interest rates on hold for the rest of the year to boost growth and contain inflation, the acting chief economist for the Organization of Economic Cooperation and Development said. In an interview, Jorgen Elmeskov said the Fed should significantly tighten monetary policy beginning in the middle of next year, while the ECB should stay on hold until the end of 2009 to hit its target of reducing inflation to slightly below 2%. Mr. Elmeskov spoke as the OECD released its annual economic outlook. That report predicted that economic growth in the U.S., Europe and Japan will slow significantly through the rest of 2008, before picking up again in 2009. Tighter lending standards, falling housing prices and much higher commodity prices should cause growth in the U.S. to stall almost completely through the rest of 2008, the OECD said. The same factors will drag on annual gross-domestic-product growth in Europe and Japan, but not as much, the OECD said, predicting growth of 1.7% in both the euro area and Japan in 2008, compared with 1.2% in the U.S. Stronger growth should return by the end of 2009, the OECD said, based on assumptions that banks won't further restrict their lending standards and that the effects of a sharp decline in housing prices will fade.

Key Sector/Indicators 

Service sector growth eases A key survey of service sector executives released Wednesday showed business activity rose at a somewhat slower rate in May, even as employers cut payrolls and prices continued to rise. The Institute for Supply Management's (ISM) non-manufacturing index fell to a reading of 51.7 from 52 in April. Economists were expecting a reading of 51, according to a consensus compiled by Briefing.com.A reading above 50 indicates growth in the sector, and a reading below 50 represents a sector-wide decline. "This report is consistent with the slow growth we're seeing in 2008," said Wachovia economist Sam Bullard. May marks the first time the index declined - albeit very slightly - since its January facelift. Prior to January's report, the non-manufacturing index was only based on business activity, but it now equally measures business, orders, employment and supplier deliveries. The reading for business activity in the service sector rose to 53.6 in May from 50.9 in April. The service sector encompasses the retail, transportation and health care sectors. It also includes sectors that have been hit hard by problems in the economy, including finance, real estate and construction.

Unemployment Rate Jumps to 5.5 Percent in May- The government reports the nation's unemployment rate jumped to 5.5 percent in May -- the biggest monthly rise since 1986 -- as nervous employers cut 49,000 jobs last month. It was a dramatic sign of a deeply troubled economy. The big jump in the unemployment rate surprised economists who were forecasting a tick-up to 5.1 percent. Payroll losses, however, weren't as deep as the 60,000 that analysts were bracing for. Still, job losses in both March and April turned out to be larger than the government previously reported. Employers now have cut payrolls for five straight months. The 5.5 percent rate is relatively moderate judged by historical standards. Yet, there was no question that employers last month sharply cut jobs in manufacturing, construction, retailing and professional and businesses services. Those losses swamped gains elsewhere, including in the education and health fields, government and leisure and hospitality. The government said the number of unemployed people grew by 861,000 in May -- rising to 8.5 million. The over-the-month jump in unemployment reflected more workers losing their jobs as well as an increase in those coming into the job market to look for work, the Bureau of Labor Statistics said. A year ago, the number of unemployed stood at 6.9 million and the jobless rate was 4.5 percent.

Stimulus Checks Bolster Retail Sales Sales at U.S. retailers rose an unexpectedly sharp 1% last month, suggesting consumers spent a chunk of their government economic-stimulus checks. But rising prices and a weakening labor market could mean the boost to the economy will be short-lived. Retail sales, a key gauge of consumer spending, rose twice as much as expected in May to $385.4 billion, the Commerce Department said. Sales in April and March were also revised upward. Excluding the weak auto sector, sales were even stronger. Economists React: Consumers Say 'What Me Worry?'

Real Estate

Foreclosures Hit Record High -- and More Coming Foreclosures surge to a record high -- late payments, too, signaling worse to come. The foreclosure hammer is hitting ever harder. People lost their homes at the highest rate on record in the first three months of the year, and late payments soared to a new high, too -- an alarming sign that the housing crisis and its damage to the national economy may only get worse. Dumping more empty homes on an already glutted market also is likely to put a further drag on home prices -- extending a vicious cycle. Slumping home values are being blamed in large part for the rising tide of foreclosures. Troubled borrowers are left owing more to the bank than their homes are worth. They can't sell without taking a huge financial hit, so they just walk away. In fact, Americans' equity in their homes -- usually their single biggest asset -- now has dropped to the lowest level on record in figures going back to the end of World War II. Homeowners' portion of equity fell to 46.2 percent, which means the amount of debt tied up in their homes exceeds the equity they have built up. Both the rate of new foreclosures and late payments were the highest on record going back to 1979. Nearly 8.5 million homeowners had negative or no equity in their homes at the end of March, representing more than 16 percent of all homeowners with mortgages, according to Mark Zandi, chief economist at Moody's Economy.com. He estimates that will increase to 12.2 million, or almost one out of every four homeowners, by the end of June. Toll CEO: Housing depression, Existing Home Sales: Turnover Will Slow, Case-Shiller: Real Prices off 21% from Peak

The Next Real Estate Crisis With the subprime mortgage crisis already crippling the U.S. economy, some experts are warning that the next wave of foreclosures will begin accelerating in April, 2009. What that means is that hundreds of thousands of borrowers who took out so-called option adjustable-rate mortgages (ARMs) will begin to see their monthly payments skyrocket as they reset. About a million borrowers have option ARMs, but only a fraction have already fallen due. That was the catch to option ARMs; borrowers were offered low initial payments that would recast higher after several years. Many home buyers thought they could resell their homes before their payments increased. But instead, many of them got trapped. According to Credit Suisse (CS), monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010. Some of these loans have already started to recast. About 13% of option ARMs that were issued in 2006 were delinquent by 60 days by the time they were 18 months old, Credit Suisse said. Option ARM reset schedule previous and revised (BW Graphic).

Wachovia: CRE Slump is Here The faltering housing market and generally sluggish pace of the overall economy are finally taking a toll on the commercial real estate market. Demand for office, industrial and retail space is waning, sending vacancy rates higher and property prices lower. Real private nonresidential construction is expected to moderate in the second quarter and continue to slide under the weight of tightening underwriting standards and slower economic growth. Here is my fairly long Non-Residential Investment Overview with similar conclusions. Also - this coming slump in CRE is one of the reasons the FDIC and the Fed are so concerned with bank failures later this year.

Business Outlook

NFIB Index Points to Higher Increase in Jobless Rate Small business owners are not optimistic about the current state of the economy. "The National Federation of Independent Business Index of Small Business Optimism fell 2.2 points to 89.3 - a recession-level reading, and the lowest index reading since 1980," said NFIB Chief Economist William Dunkelberg. "But the current low readings have not been accompanied by the declines in real spending and hiring as was the case in past recessions," he said.   There was a modest decline in employment in May (seasonally adjusted). Six percent of the owners increased employment by an average of 4.7 workers per firm, and 16 percent reduced employment an average of 2.9 workers per firm, virtually identical to the April numbers. More firms are reporting deteriorating sales trends than sales gains, quarter over quarter. The net percent of all owners (seasonally adjusted) reporting higher sales in the past three months was down two points, falling to a negative 11 percent (seven points worse than September). Unadjusted, 23 percent of all owners reported higher sales, and 38 percent reported sales lower.

Bigger U.S. bank failures may be coming - FDIC Future U.S. bank failures linked to the downturn in the real estate market may include "institutions of greater size" than in the recent past, Federal Deposit Insurance Corp Chairman Sheila Bair said on Thursday. An increasing number of banks face high exposure to deteriorating conditions in commercial real estate and construction lending, Bair told a Senate Banking Committee hearing on the state of the banking industry. "There is also the possibility that future failures could include institutions of greater size than we have seen in the recent past," Bair said. "Uncertainties in today's economic environment continue to pose significant challenges for the banking industry, households, and bank regulators."

Wealth vs Demand

Americans $1.7 trillion poorer Americans saw their net worth decline by $1.7 trillion in the first quarter - the biggest drop since 2002 - as declines in home values and the stock market ravaged their holdings. Meanwhile, the amount of equity people have in their homes fell to 46.2%, the lowest level on record. The net worth of U.S. households fell 3% to $56 trillion at the end of March, according to the Federal Reserve's flow of funds report, which was released Thursday.The value of real estate assets owned by households and non-profits declined by $305 billion, while financial assets fell by $1.3 trillion, led mainly by a $556 billion drop in stocks and a $400 billion decline in mutual funds. The first quarter's decline follows a $530 billion drop in wealth in the fourth quarter of 2007. Until then, net worth had been rising steadily since 2003, climbing nearly 31% over those five years. During the bear market of 2000 through 2002, household's net worth dropped 6.2%. The recent declines, however, may not affect consumer spending, said Michael Englund, senior economist with Action Economics. Americans have actually spent more in recent months, particularly at the gas pump as fuel prices soared. Americans "are spending everything in their wallet and borrowing more," Englund said. "But because the pump takes so much more of their dollars, they are buying fewer T-shirts." Still, as people feel begin to feel poorer, the growth in consumer spending may slow, said Scott Hoyt, senior director of consumer economics at Moody's Economy.com. "When wealth goes down, consumers will cut back some," he said. "There will be a drag on spending."Household debt grew by 3.5% in the first quarter, down from 6.1% in the fourth quarter. The growth of home mortgage debt, including home equity loans, cooled to an annual rate of 3%, less than half the pace of 2007. Consumer credit, which includes credit cards, rose at an annual rate of 5.75%, the same as the 2007 pace. The fact that consumers continue to borrow against their homes, even as they decline in value, shows how troubled Americans are.

Wealth Evaporates in U.S. as Fuel Prices Clobber McMansions, SUV Makers ``Our whole economy reflects the relative costs of energy: the cars we drive, the houses we occupy, the kinds of factories we have and the equipment in them,'' says Dana Johnson, chief economist at Comerica Bank in Dallas. ``I'm expecting relatively large changes in all of these things.'' The loss of wealth could be a double whammy for the U.S. economy. In the short run, it depresses demand as homeowners save more and spend less, and companies fire workers. Longer run, it curbs productivity growth, as firms shift their focus from increasing worker efficiency to reducing energy costs. ``At $4 per gallon gas, $125 per barrel oil and $10 per million Btu natural gas, a lot of activity becomes uneconomical,'' says Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania. ``The change in energy prices makes a portion of the capital stock obsolete,'' says Richard Berner, co-head of global economics at Morgan Stanley in New York. ``That will depress demand.'' He sees the U.S. economy growing at a sub-par 1.4 percent next year after expanding just 1 percent in 2008, held back by a variety of forces that include the destruction of capital resulting from the rise in energy prices. Zandi at Moody's Economy.com says permanently higher fuel costs will depress productivity growth during the next three to five years as companies retool to boost energy efficiency.

House Prices, the Wealth Effect and the Cash-in-Hand Effect House prices are collapsing, which means that homeowners’ equity in their houses is plunging. According to Federal Reserve flow-of-funds data, homeowners’ equity dropped by $399 billion quarter-to-quarter in Q1:2008 and $880 billion year-over-year – both record absolute declines (see Chart 1). The drop in homeowners’ equity contributed significantly to the $1.7 trillion decline in household net worth in the first quarter (see Chart 2). Economists refer to something called the “wealth” effect. It is hypothesized that households tend to spend relatively more of their income when their wealth is increasing and vice versa. Mind you, households do not have any more cash in hand to spend when the value of their stock portfolios or houses go up. They are just wealthier “on paper.” Active Mew has slowed to only $114 billion in the first quarter of this year – the smallest amount since the fourth quarter of 1999 (see Chart 3). There is no doubt in my mind that active MEW, which actually puts additional cash into the hands of households, played an important role in boosting consumer spending in this past expansion. And there is no doubt in my mind that the recent and likely continued decline in active MEW will play an important role in retarding consumer spending in this recession. Q1 2008 Mortgage Equity Withdrawal: $51.2 Billion

Americans enter new cycle as tough times alter spending habits Wondering how consumers are coping in such a troubled economy? Look at what's selling instead of which sales are tanking.  As consumers muddle through all that is plaguing the U.S. economy, they have battened down the hatches and sharply shifted their spending habits, turning to money-saving options that run the gamut from transportation to health as they find ways to pay for dramatic increases in gasoline and food. What emerges is a new paradigm of consumerism that some experts believe will live long after this economic crisis is resolved. "Suddenly consumers are focused on buying what they have to have as opposed to buying what they want to have," said Howard Davidowitz, chairman of Davidowitz & Associates, a New York-based retail consulting and investment-banking firm. "This is a permanent change for Americans, who will face a declining standard of living over the next 20 years," he added.