Delving into 2012: 'Recession of Confidence' Slows Economy

Jan. 1, 2012
What we now call the Great Recession officially began in December 2007 and ended in June 2009. It was the longest, deepest, and most painful recession since the Great Depression.

What we now call the Great Recession officially began in December 2007 and ended in June 2009. It was the longest, deepest, and most painful recession since the Great Depression.

By my count, that suggests that the current U.S. economic expansion is now reaching the two-and-a-half year mark. The current expansion has been less than satisfying both statistically and emotionally, with major headwinds still in play involving weak residential and commercial real estate markets, uncomfortably high unemployment, major European financial risk, and elevated levels of anxiety about the direction of the federal government.

The current U.S. economic expansion has been especially lackluster when considering the massive and unprecedented levels of both fiscal and monetary stimulus. While modest economic growth has returned, a "recession of confidence" remains center stage.

Economic growth in 2012 is likely to remain substandard, with most forecasts congregating around a 1.5% to 2.5% real (inflation adjusted) rate of growth. More bearish forecasters see particularly anemic growth in 2012’s first half.

The size and scope of a possible European financial implosion could lead the U.S. and much of the world back into recession, although that is not the consensus view. Nevertheless, investors around the globe have taken a "shoot first, ask questions later" approach to European sovereign debt markets and the contagion that has now spread to more and more members of the euro community.

Our Government
Political theater of the absurd has been commonplace in the nation’s capital, with extreme partisan politics today’s reality. The government’s ability to live within its means remains highly elusive, even as European developments should be sending strong signals to Washington about damaging annual budget deficits and a more than $15 trillion (that’s $15,000,000,000,000) gross national debt.

Various economic studies have suggested that any nation’s ability to prosper and grow at a satisfactory pace is endangered when its gross national debt reaches 90% of that nation’s annual economic output. We are now at 100% . . . and rising quickly.

Trillion dollar-plus budget deficits of the past three fiscal years will continue for as far as the eye can see. The biggest threat to this nation is the financial cancer of irresponsible government deficits.

And just in case you’re already tired of the political battles under way, be aware that the 2012 presidential race will only heat things up more. The failure of the “super committee” was the latest in government missteps. An emotional national debate about the size and growth pace of the federal government, and who pays for it, will be key elements of political discussion during most of 2012.

U.S. Employment
Wary business leaders and worried consumers have contributed to the weak level of American job creation during the current economic recovery. The nation has regained only one-fourth of the eight million jobs lost during the crisis of 2008 and 2009. Unless and until confidence levels improve, weak additions to employment will continue.

The nation’s unemployment rate has averaged 9.0% for the past three years. Most forecasters see an unemployment rate of not less than 8.5% by the end of 2012.

To be heard frequently during the presidential campaign now under way is the fact that no sitting president in the past 75 years has been rewarded with a second term when the unemployment rate was above 7.2%. Whether President Obama can shift the blame for high unemployment to intransigent Republicans in the Congress will have a telling impact on election results.

U.S. Inflation
Consumer prices are expected to have risen roughly 3.5% during 2011, with a slightly lesser rise the consensus view for 2012. Weak global economic growth could lead oil prices lower, a key element in that forecast. Over a longer time horizon, the debate continues between those expecting higher U.S. inflation and those seeing a Japan-style deflation in the U.S.

The Federal Reserve
The Federal Reserve Bank’s most critical interest rate—the federal funds rate—has been at an all-time low target level of 0.00% to 0.25% since December 2008. Moreover, the Fed’s Open Market Committee has stated they expect this rate to remain unchanged until at least mid-2013.

In addition, the Fed has tripled the size of its balance sheet by buying massive amounts of U.S. Treasury securities and mortgage-backed securities. The intent? To drive long-term interest rates lower. While such actions have been largely successful, weak home prices across the nation, high unemployment, and a more paper-intensive lending industry has not led to a strong surge in mortgage refinance activity.

Housing and Mortgage Rates
Most forecasting economists see national home prices stabilizing by mid-year 2012, with very modest price appreciation to follow. At the same time, conventional 30-year fixed-rate mortgages have been at a 60-year low near 4.0% in recent weeks.

One could make a case to delay a home purchase for 6 to 12 months, but mortgage rates could rise enough to offset any slightly lower home price. Now may be an outstanding time to purchase a new or foreclosed property or refinance an existing mortgage.

Global Keys
Chinese and Indian economic growth are likely to slow somewhat, while Japan struggles with very substandard performance. High oil prices have boosted oil-producing nations at the expense of user nations. The Canadian economy has slowed, while Mexico and Brazil are doing well.

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However, these days it’s all about a fragile European economy. Greece, Ireland, and Portugal have already been bailed out, while major anxiety exists about Spain and Italy. Even the French have seen borrowing costs rise as questions about that economy have surfaced. A possible French downgrade from its current “triple A” status could send additional shock waves across Europe.

The Germans and the International Monetary Fund will face rising pressure to stem European debt contagion, even as impacted nations face the real need to get spending and debt issuance under control. No other issue is more critical to global economic performance in 2012 than a solid resolution of the European debt crisis.

Jeff Thredgold is president of Thredgold Economic Associates, Clearfield, UT. He served 23 years with KeyCorp., one of the nation’s largest financial services companies, as senior vice president and chief economist. This article is adapted from his newsletter, the Tea Leaf. For more information or to subscribe to the Tea Leaf, visit

THE RESIDENTIAL HVAC MARKET: Multi-family will run hot, single-family cold

By Ken Simonson

HVAC residential contractors will have one foot in a steaming cauldron and one in an ice bucket as they enter 2012. The hot foot will be from new multi-family projects, while single-family new and replacement work remains in a deep freeze.

Multi-family construction started to awaken from a multi-year slumber in late 2010. By October, spending was up 7% from a year earlier, according to the Census Bureau. But permits climbed 48% over the same period, and starts rocketed 89% higher. In addition, commercial real-estate analysis firms reported declining vacancies and rising rents in nearly all metropolitan areas. These are very positive signs of a strong and lasting upturn in construction in 2012 and probably beyond.

In contrast, new single-family construction permits, starts, and spending put in place were all virtually dead level with year-ago totals—emphasis on “dead.” Existing-house prices were still declining in most of the country, while sales were higher but not enough to bring down inventories significantly. New-home sales were at historic lows. All of these indicators suggest new-home construction will not revive any time soon.

The repair and replacement market may do slightly better. Personal incomes are rising modestly and more consumers are reducing debt, putting them in better shape to spend on maintenance and upgrades for consumer durables. There is also an unfortunately large demand for repair and replacement of systems that have been vandalized as thieves rip out copper from unprotected foreclosed homes. But there is little reason to believe the replacement market will grow appreciably in 2012.

Speaking of copper—and other materials—2012 should be a bit less of a roller coaster for prices than the year just ended. In 2011, copper futures soared to an all-time high of $4.60 per pound before subsiding to $3.40 to $3.60 by mid-December, lower than at the end of 2010. Diesel fuel and steel also spiked early in the year, then settled back, though not to late-2010 levels. In 2012, these materials will have less-violent price movements. But gypsum makers have threatened to raise wallboard prices by 35% at the beginning of 2012. Putting all materials together, you can reasonably expect the year-end price rise will be similar to the 5% increase in 2010 and 2011.

THE COMMERCIAL HVAC MARKET: Watch for a private upturn, public u-turn

The nonresidential construction market is performing a do-si-do dance in 2012. Public construction, which had been out in front for the past two years, will fall back, while private nonresidential construction steps to the fore.

The best-performing nonresidential segments are likely to be power and energy (especially work associated with shale-based natural gas and oil deposits), manufacturing and warehouse/distribution/transportation terminals. None of these categories provides much work directly for commercial HVAC contractors but they do offer spill-over benefits, putting more money into communities where they are located. In particular, the oil and gas projects are bringing new workers into regions such as rural Pennsylvania, Ohio, Texas, and North Dakota that have had little, if any, population growth in recent decades. That stimulates demand for motels, stores and services, and longer-term housing.

Hospital construction should be at least a modest winner in 2012. Improved stock-market conditions mean hospitals can again rely on endowments and capital campaigns to finance upgrades and new construction. In many metro areas, there has been consolidation among competing hospitals, leaving the survivor in stronger financial shape to expand and modernize.

There will be little new retail, office or hotel construction in most of the country in 2012. But shopping centers and office owners will spend on renovations to retain or attract tenants. Investors who have bought distressed hotels will be upgrading them. Some of the spending may go for HVAC improvements.

On the public side, the news is bleak. The federal government put extra money into construction and renovation in 2009-2011 through several aspects of the 2009 stimulus legislation and the military base construction that followed recommendations of the 2005 Base Realignment and Closure Commission. But that spending is largely done, and Congress is now cutting regular appropriations from many agencies. School districts and other local governments also are ratcheting back on construction and even maintenance as the property taxes that their budgets depend upon keep shrinking, tracking the fall in house prices. State government revenues have been on the rise, but higher spending on income-support programs and underfunded public employee pension plans has left little for construction.

Overall, the upswing in private nonresidential construction should offset the drop in public spending. But the changes will vary greatly by category, and not all HVAC contractors will be left whole.

Ken Simonson is chief economist, Associated General Contractors of America. He can be reached at 703/387-5313, or by e-mail at [email protected]