2014 Outlook: Potholes In The Road Ahead

2013 Charlie HallThree major policy challenges are converging in January that will set the stage for the economy early into 2014: budget, Obamacare and the debt ceiling. It’s the ultimate three-ring circus.

Government spending authority as part of the latest continuing resolution expires in the middle of the month, just three weeks ahead of the debt ceiling deadline of February 7.

There is also likely to be ongoing agonizing about the implementation of Obamacare. January 1 was the deadline for individuals to have insurance. If the website isn’t completely fixed or if young and healthy Americans haven’t yet signed up for coverage, insurers will begin panicking and Obamacare itself could start to unravel. Millions of healthy individuals are needed in the exchanges to subsidize the costs of treating sick and elderly patients.

With his approval ratings exploring new lows, Obama has little political capital for leverage. He won’t be able to run the tables on all three of these major issues. He will have to give somewhere.

Politics aside, even though there were plenty of headwinds in 2013 and the attitude today may be one of caution and uncertainty, there is a resiliency that should embolden even the most jaded and give a bit of hope heading into 2014.

Business As Usual Or Cause For Concern?
Some economic indicators point to some concerns in the second half of 2014 related to a recalibration that is expected to occur in the stock market some time during the summer. This correction is projected to be mild, however, and has been referred to as the economy running over a pothole rather than swerving into a ditch.

Interestingly, some of the more infamous economic modelers are inferring that the fallout from the financial crisis and the Great Recession have returned the United States to a more normal sequence of business cycles. They maintain that we are exhibiting economic behavior closer to the long-run average (33 cycles between 1854 and 2009) where expansions were shorter (about three years as opposed to the post-1961 average of six years) and contractions a bit longer (18 months) than the 12-month contractions that are the post-1961, seven-cycle norm.

By the long-run standard or even by the full post–World War II (1945–2009) standard that saw expansions averaging 59 months, the current expansion, at 54 months, may be getting close to its end. The standard deviation of postwar expansions is 33.4 months, so we are well within the “window” for the onset of a recession.

The teachable moment for green industry firms, in my mind, is that the Lake Wobegon environment for our industry has dissipated. It’s time to develop some specific strategies for competing in economic periods of expansion and contraction. We have the ability to make money in the midst of both types of environments, but we have to be proactive in doing so. This means being acutely aware of driving forces such as demographic trends, housing trends, etc.

The Housing Market Is Strong But Not Stellar
The strength there has been in the economy during this latest period of expansion has been due to the invigorating influence of the housing sector. Housing starts were expanding at a 31 percent annual rate at their peak last March, but that slowed to a 26 percent annual rate of expansion by the close of 2013 — still very good but not stellar. The downward projection in the rate of growth is likely to continue into 2014, but the double-digit gains in home values and the 1.2 million projected housing starts (highest levels since 2008) are major boosts to consumers and contractors.

In the year ahead, real GDP is expected to rise at a 2.3 percent pace, driven in large part by improvement in consumer spending, business fixed investment and residential investment. Consumer spending for big-ticket items remains relatively strong. The modest pickup has been driven by better payroll growth and a marked improvement to consumer balance sheets.

Household assets are now greater than their pre-recession peak as home prices and the stock market have helped to restore balance sheets. However, some of the gain in home prices and the stock market has been boosted by securities purchased by the Federal Reserve to help keep long-term rates low. With rates at such a low level, investors searching for yield have put money to work in hard assets like homebuilding and the stock market.

Will The Fed Taper Or Is The Market Strong Enough?
Many are concerned that once the Fed begins to scale back its asset purchases, some of the gains in the residential and stock market will dissipate. This concern raises questions about when the Fed will announce its intention to taper. Are fundamentals strong enough to continue to buoy the residential market when that happens? Let me explain this a bit.

The Fed has used quantitative easing (QE) to fuel growth. This means it started buying long-term financial assets or bonds from commercial banks and private institutions, aimed at reducing the yield on bonds that would have led to lowering of borrowing costs, and ultimately fueling growth. So far, there have been three rounds of QEs, popularly known as QE1, QE2 and QE3, through 2008 to 2013. When the Fed gradually reduces funding to this bond purchase program, it is called tapering.

It seems reasonable to assume that the actual process of tapering will be slow and gradual with the goal of minimizing any potential market disruptions. This is precisely where the difficulty resides. After all, the Fed cannot continue expanding the money supply at the current rate; therefore, the key issue is to taper with the least amount of market disruption. I suspect this will include sending up trial balloons to gauge the market’s reaction to various Fed actions, executing the tapering process and having contingency plans in place to address any significant issues that may arise.

What will be the specific impacts of tapering? Most believe that tapering will result in an increase in interest rates, especially at the longer end of the yield curve. This could have two detrimental effects:

  1. Higher mortgage rates. In this scenario, the housing recovery that is critical to a thriving economy could slow dramatically. Therefore, tapering at the present time would be risky.
  2. Cost to the federal budget. If tapering does indeed lead to higher interest rates, the increased cost to the federal budget would be a considerable impediment to fiscal policy health. I heard an interesting statistic recently that said if interest rates were to rise by one percentage point, it would completely erase the budget savings created from the sequestration.

Develop Your Operation’s Contingency Plan Now
The bottom line is that now is the perfect time to develop your economic contingency plans. When times are good, the goal is usually to grow the business. In an extreme downturn, you will have only one goal: survival. In a mild or moderate recession, however, you have room for additional goals. It is possible to make money during each of these economic scenarios, but you have to plan for it. As the saying goes, fail to plan and you plan to fail.

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