By Gerry Donohue. Barring war or terrorist attack, the U.S. economy will climb back on its growth track in 2003. It won't be the technology-bubble economy of the late 1990s, but 2003 should be a solid year.
"We have gone from boom to average, not boom to bust," says Standard & Poor's chief economist David Wyss. "It doesn't feel that way. We have become so used to prosperity that we don't recognize normality."
For its part, housing will continue to prosper. Through the boom years of the 1990s, the recession of 2001, and the sluggish recovery of 2002, the housing industry charged ahead. Next year will see a slight slowdown, but it will still be one of the strongest years in the past two decades.
"We expect starts and sales to drift lower, simply because so many have already bought," says Wyss. "The levels, however, will remain high."
No economist gets very far into a forecast for 2003 before mentioning the dangers. At no time in recent memory have so many potential shocks threatened the economy. Topping the list of worries are terrorist attacks on the U.S. mainland and a war with Iraq, but others include corporate accounting scandals, foreign economic problems, and an erratic stock market.
"We don't know if or when any of those things might occur or what their impact would be," cautions Fannie Mae chief economist David Berson. "In the past, such events have knocked growth back. With the slow growth we have right now, it would probably be enough to push us back into recession.
"In the absence of one or more of these shocks," Berson adds, "the economic rebound should continue and intensify in 2003."
The Blue Chip consensus forecast of 50 leading economists for Gross Domestic Product (GDP) growth in 2003 is 3.2 percent. Most economists see the economy picking up pace as the year progresses, with the first quarter being the weakest and the fourth quarter pumping along at a rate of close to 3.5 percent GDP growth.
The primary boost to the economy will come from the fiscal and monetary stimuli injected into the system during the past 24 months. The fiscal stimulus comes from the return to federal deficit spending. In the course of a little more than a year, the federal government has gone from a surplus of about 2 percent of GDP to a deficit of about 2 percent of GDP. That combination of tax cuts and increased spending has poured a tremendous amount of liquidity into the economy and the full impact should be felt in 2003, say economists.
On the monetary side, the Federal Reserve has cut interest rates 11 times since the beginning of 2001, pushing the rates to the lowest levels seen in 32 years. Interest rate cuts, however, take a long time to have an impact on the economy; most of the positive impact will be felt in 2003.
Several other factors should contribute to a stronger economy. Fannie Mae's Berson says inventory levels for business in general have fallen to record lows. "We will have to see increases in production to bring them back up," he says. "In fact, after falling for 15 consecutive months, business inventories rose 0.4 percent in May, followed by similar increases in both June and July."
Unemployment has been climbing steadily from its historic low of 4 percent in 2000, but it is still less than 6 percent, which has been the average during the past 42 years. As the economy improves, Blue Chip economists foresee the unemployment rate stabilizing in 2003 at about 5.8 percent.
Inflation — historically a threat to growth — seems to have been tamed. Inflation has been more of a memory than a danger due to the Federal Reserve's focus on keeping it at bay. Given the Fed's recent rate cutting and expressed willingness to enact more cuts if necessary, inflation worries don't even show up on the forecast for 2003. Nevertheless, economists expect the Federal Reserve to reverse course on rates once the economy starts to show consistent strength, because they fear growth-induced inflation in 2004 and 2005.
"The Federal Reserve probably will start to raise short-term interest rates by the spring of 2003, moving away from its aggressive anti-recession stance as the economy strengthens," says NAHB chief economist David Seiders. "We expect the Fed to raise the federal funds rate, and thus the bank prime rate, by about 1.25 percentage points by the end of 2003. And long-term rates, including the fixed-rate home mortgage, probably will move up by about half a percentage point over the course of the year."
Even with these increases, most economists forecast that mortgage rates will be below 7 percent by the end of 2003. Seiders' forecast is for rates to gradually climb to 6.8 percent. S&P's Wyss is the most optimistic, putting the fixed rate at 6.4 percent by year's end.
As all these factors boost the economy, they also should boost the confidence of consumers, who are the real driving force behind the economy and who have been battered by more than $7 trillion in losses in the stock market during the past two-and-a-half years.
"At least half of economics is confidence, at least in the short run," says S&P's Wyss. If consumers are buoyed by job growth and tamed inflation, they will become confident enough to buy, which will improve the economy and prompt them to keep buying.
"There's been a lot of talk about how bad consumer confidence is, but we're coming off some really high readings," says Seiders. "If you look over the longer term, consumer confidence has remained quite high. And it will definitely improve as the stock market and job market improve."
Housing Keeps Humming
Housing has been a sound structure for sustaining consumer confidence since mid-2000. It has been a source of financial security and one of the few opportunities to build wealth. As a result, the industry started an estimated 1.65 million units in 2002, the highest level since the tax-incentive building years of the mid-1980s. In June 2002, the annual rate of new home sales topped 1 million for the first time. As other economic sectors improve, housing will pull back from its full-capacity pace, but it will continue to be a vibrant market throughout 2003.
Real GDP (Chained '96$)
% Change: 2003 from 2002 (year over year)
|Standard & Poor's Corp.||3.7|
|SOM Economics, Inc.||3.7|
|Moody's Investors Service||3.6|
|Bear Stearns & Co., Inc.||3.4|
|National City Corporation||3.3|
|Turning Points (Micrometrics)||3.3|
|Naroff Economic Advisors||3.2|
|National Assn. of Home Builders||3.2|
|Inforum - Univ. of Maryland||3.2|
|J P MorganChase||3.2|
|Eggert Economic Enterprises, Inc.||3.2|
|Deutsche Bank Securities||3.1|
|Macroeconomic Advisers, LLC||3.1|
|National Assn. of Realtors||3.0|
|Wayne Hummer Investments LLC||3.0|
|U.S. Chamber of Commerce||3.0|
|Ford Motor Company||3.0|
Kellner Economic Advisers
|Evans, Carroll & Assoc.||3.0|
|Huntington National Bank||2.9|
|General Motors Corporation||2.9|
|LaSalle National Bank||2.8|
|Wells Capital Management||2.8|
|Schwab Washington Research Group||2.8|
|Federal Express Corp.||2.7|
|Georgia State University||2.6|
|Northern Trust Company||2.6|
|Credit Suisse First Boston||2.6|
|UCLA Business Forecasting Proj.||2.6|
|Banc of America Corp.||2.5|
|Goldman Sachs & Co.||2.3|
|Daiwa Institute of Research America||2.1 (low)|
Source: Blue Chip Economic Indicators, Aspen Publishers
The Blue Chip consensus calls for 1.61 million startsin 2003, making it the fourth best production year since 1988. Not all Blue Chip economists break down the starts statistic into single-family and multifamily. Among the housing-focused economists, the consensus is for single-family starts to total about 1.29 million and multifamily starts to come in at around 320,000. Several factors will contribute to this relative slowdown.
"In the first five months of 2003, housing starts were running at a 1.75 million pace," says Freddie Mac chief economist Frank Nothaft. "That pace just can't be sustained for the long term."
That lack of sustainability comes from both the demand and supply side.
On the demand side, the frenetic pace of home buying has pulled forward a lot of demand. Stimulated by the safe haven of housing and historically low interest rates, a lot of buyers who might have waited until 2003 or 2004 to buy a house have already jumped into the market.
Much of that hit will come on the multifamily side, where vacancy rates have been rising since mid-2002. "There has been a pretty clear movement of people out of their apartments into first-time housing," says Seiders. Despite the rising vacancy rate, Seiders says the multifamily market is healthy because there has been little or no overproduction of units. As a result, he expects the apartment market to rebound in the second half of 2003.
Prices and Appreciation
One of the primary constraints on the supply side is a swelling slow-growth sentiment. "Communities around the country are becoming increasingly concerned with sprawl and development and are taking action," says Berson. "Given the strength of sales that we have now, we would have seen many more starts in the past. Instead, we see unsold inventories at near record lows and price increases."
According to the Freddie Mac Conventional Mortgage Home Price Index, home prices increased at an annual rate of 7.6 percent in the second quarter of 2002. Such increases have raised concerns about a price bubble in housing. Economists discount that possibility on a national scale, although they say there are possibilities of price bubbles in local markets, such as Silicon Valley, Colorado Springs, and Naples.
"The housing price increases have been driven by strong demand," says Celia Chen, director of housing economics at Economy.com. "They are supportable by the fundamentals in the market." These fundamentals include strong demographic growth, low interest rates, steady income growth, and continued limited supply.
And while increased prices might be seen as a drag on the demand, Berson says they have actually helped support the housing market in particular and the economy in general. "Housing gives you wealth just as the stock market gives you wealth," he says. "Studies have shown that changes in housing wealth have more impact on spending than changes in stock market wealth because people perceive that home values are more permanent."
While the values may be permanent, the pace of price appreciation will slow in 2003. According to Freddie Mac's Nothaft, during the past 26 years, appreciation has exceeded inflation by an average of 1.3 percentage points. In the second quarter of 2002, the spread exceeded 5 percent. Nothaft says he expects that difference to narrow in 2003, with home appreciation averaging five percent.
Looking long term, housing should enjoy several strong production years. The equilibrium demand for new homes, which consists of new household formations, home replacements, and second homes, is estimated to be between 1.4 million and 1.65 million. Most housing-focused economists put the number close to 1.6 million.
"Our forecast says we've been running and expect to be running sustainable trends for this decade," says Seiders, who puts the equilibrium demand at 1.6 million. Considering that starts averaged about 1.37 million annually in the 1990s, such a forecast bodes extremely well for housing.
In addition to the primary forces behind that demand, two factors will support housing for several years. First is the unprecedented pace of immigration in the 1990s. According to the 2000 census, there are about six million more Americans than anticipated, almost all of the surplus due to immigration. Many of these people have now established themselves in the economy and are expected to enter the housing market soon.
"These immigrants are filling what was perceived to be a hole in the housing demographics, that of the first-time buyer," says Seiders. "They are supporting the very strong demographics of the trade-up market."
The second factor is the emotional scarring from the plummeting stock market. Many Americans perceived the stock market as their source of wealth and retirement security. The majority of U.S. households are invested in stocks; many had most of their savings in the stock market. According to the Investment Company Institute and Securities Industry Association, nearly half of all U.S. households owned stocks at the start of 2002, up 7 percent from 1999. Having watched their net worth shrink and in some cases disappear, many are hesitant to start investing again.
"The mania of the late 1990s and 2000 got totally out of hand," says Seiders. "We've had a rather rude awakening as to what reality looks like. I think it could be as long as 10 years before people are willing to commit to the stock market again." And for many of these people, housing will be their primary repository of wealth.
Published in BIG BUILDER Magazine, December 2002