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Marshall J. Vest
Forecasting Project Director
June 1, 2009
The U.S. and Arizona economies remained in free fall during the first quarter of 2009, continuing the plunge that began in the fourth quarter. Early reports for the second quarter suggest that nationwide, a bottom is beginning to form as the rate of decline diminishes and a few measures begin to turn upward. We continue to expect the recession nationwide to come to an end during the summer followed by a gradual recovery. Arizona is expected to lag behind by at least a quarter or two due to lingering challenges facing real estate and massive layoffs in the public sector that still lay ahead.
The worst of the financial crisis and the economic downturn appears to be behind us as data for the second quarter begins to arrive. Consumers, investors, and businesses all appear to be tired of hunkering down and are beginning to re-engage. Financial markets and the banking system are improving, and the federal stimulus package is set to provide a big boost.
On the national scene, consumers are growing more confident, and retailing has improved in recent months. Support for spending includes lower gasoline prices, a wave of mortgage refinancing, and tax refunds from the federal government in the form of reduced withholding on paychecks and rebate checks for Social Security recipients. Consumers also are buoyed by rising financial markets as major stock indexes have gained some 30% since early March.
Businesses have slashed payrolls and investment spending during the past year, and they significantly reduced inventories in the first quarter. The recent firming of sales means that profits, cash flow, and production will move upward in the coming months.
Credit markets also are looking much better. The yield spread between high yield corporate bonds and 10-year treasuries has narrowed to about half of the spread last fall during the credit market freeze. The gap between the three-month LIBOR rate and comparable Treasury bill yields, which reflects willingness of banks to lend to one another, is now almost back to normal. Results of the fed’s “stress tests” of the nation’s largest banks also provides much needed information about how much new capital must be raised for each bank. Investors, who can now make informed decisions about downside risks, have in recent weeks eagerly responded to stock offerings of affected banks seeking to raise capital.
Other positive factors include infrastructure spending, spurred by the Federal stimulus package that will provide a much needed boost to the construction industry in coming months. Housing markets also are getting a boost from record-low mortgage rates, lower housing prices, and a federal tax credit of up to $8,000 for first-time homebuyers. Housing affordability now stands at a record high, signaling that now is a great time to buy a house.
The national recession is expected to come to an end this summer, with a muted recovery to follow. Historically, recoveries have been powered by interest-sensitive housing and automobile manufacturing and neither appears ready to power a strong recovery. Housing remains burdened with too many vacant homes that will take an extended time to absorb. For new cars, there is an absence of pent-up demand following the high levels of sales in recent years. Additionally, credit markets and the banking system will require at least a couple more years to get back to normal. And if that weren’t enough, commercial real estate markets are just beginning to enter a correction phase and will act as a drag on the economy near term. This means that robust growth is unlikely to return before 2011, and losses suffered during the “Great Recession” likely won’t be recovered until 2013.
Recent Evidence for Arizona
The “green shoots” identified in the national press are not yet visible at the state level. At this writing, there is little data as yet covering the second quarter for states or local areas. The first quarter data showed that the Arizona economy continued to collapse, much as we had expected. We’ll need at least another quarter of data before promising signs emerge for Arizona.
Nationwide, retail sales improved in January and February before declining modestly the following two months. In Arizona, declines continue uninterrupted; sales peaked in early 2007 and were declining at a 13.5% seasonally adjusted annual rate in February, the most recent month available. In this environment we welcome news that declines are getting smaller. So the good news is that current readings are better than the 20% rate of decline experienced in last year’s fourth quarter.
Arizona personal income increased by only 2.7% in 2008. While Arizona registered one of the smallest increases (ranking 47th among all states), its population grew faster than all but one state (Utah). So, it’s not surprising that per capita personal income grew only 0.4 percent, ranking Arizona at the bottom of all states. Quarterly data shows continuing deterioration as personal income contracted at a 1.3% and 2.6% compound annual rate in the third and fourth quarters, respectively.
We expect current dollar personal income to continue to contract through the first half of 2009 and show a loss of 1.2% for the entire year. Growth returns next year with a miniscule gain of 0.2%, followed by a 4.0% gain in 2011. The “U-shaped” bottom for constant dollar personal income over 2008-10 is similar to that experienced during 2001-03 (Exhibit 1).
The current crop of employment data through March shows continued deterioration in labor markets. Nonfarm jobs statewide plummeted at a 9.5% annual rate in the first quarter and were 6.4% lower than one year earlier! With data through March, Arizona ranked 50th for year-over-year job growth. Since topping out in October 2007, some 209,000 jobs have been lost statewide, a decline of 7.8%. Unfortunately, the losses have not yet begun to moderate.
The most recent data for employment dynamics unfortunately lags significantly because it is based on unemployment insurance premiums paid by employers (the QCEW program). With data through 2008Q2, we see that some 135,200 jobs were added while 169,000 jobs were lost during the April through June 2008 period. That’s a net loss of nearly 34,000. So while aggregate employment is declining, it’s still possible to find a new job, but if you still have one, now is not a good time to go looking. The lion’s share of the new jobs is in expansions of current firms (105,200) rather than in new firms (30,000). Likewise, losses at continuing firms (132,400) dwarf the numbers for firms closing their doors (36,600) (Exhibit 2).
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Unemployment insurance claims, an excellent leading indicator, also continue to soar statewide, nearly doubling during the past 12 months. When this measure turns, it will signal that the end of recession is near. With claims still rising, we can expect the state’s unemployment rate to rise significantly higher. In March the rate stood at 7.8% compared to 4.7% one year earlier. We now expect unemployment to approach 11% by the end of this year and that it will be 2012 before unemployment falls below six percent again (Exhibit 3).
Residential homebuilding in Arizona has all but ceased. Only four thousand units were permitted during the first quarter. Less than 900 of those were multi-family. Since the peak way back in August 2005 – three-and-a-half years ago -- permits have plummeted nearly 91%. (And when they’ve fallen 100%, there are none left).
Market-wide indexes of home prices also continue to decline. Median prices of homes sold on the MLS have fallen to only $120,000 in metro Phoenix as of March 2009. That’s down 43% from a year ago and at a 50% annual rate during the first quarter. Comparable prices in metro Tucson have fallen only 17% in the past year to $165,000; the rate of decline in April was 11.1%.
The Standard & Poor’s Case-Shiller House Price Index for metro Phoenix has fallen 50.8% since peaking in June 2006, and is now back to January 2002 levels. It continues to fall at a rapid rate (42% annualized in February). This index includes repeat sales of houses financed with “exotic” mortgages of recent years.
The Federal Housing Finance Agency (FHFA) house price index (aka OFHEO) continued to decline in last year’s fourth quarter in both Tucson and Phoenix. This repeat sales index shows peak-to-current declines of 22.4% in Phoenix and 12.2% in Tucson. The declines are much less than the Case-Shiller index since only properties with conventional financing (conforming loans) are included.
It’s next-to-impossible to determine how much the value of a typical house has declined by looking at these indexes. The wide disparity exists primarily because each shows averages for different samples of the market. As the proportion of distressed sales grows, the MLS and Case-Shiller indexes have plummeted. In recent months, two-thirds of sales in the Phoenix area and 70% in Pinal County were bank owned, according to the Phoenix Housing Market Letter (R.L. Brown).
Unfortunately, some appraisers (realtors) include distressed sales in their appraisals (CMAs), even though these distressed sales are a very different product -- and are therefore not comparable. Doing so depresses values for “normal” sales by homeowners whose home is occupied and has been well maintained. Homeowner properties have not declined in value nearly as much as aggregate price measures suggest.
The good news is that lower prices, coupled with record low mortgage rates and an $8,000 tax credit for new homebuyers, now is a great time to buy a house. Investors are responding by pouring money into the market. In metro Phoenix, investors are buying up thousands each month (6,500 MLS listings sold in March). Since bottoming at the end of 2007, the number of houses sold on the Multiple Listing Service has jumped by 74%. The rate of foreclosures in metro Tucson is much lower than in Phoenix and prices have not dropped nearly as much. As a result, existing home sales remain at a cycle low in Tucson (a 10,000 annual rate).
The number of active listings is declining in both metros, even as foreclosures come to market. In metro Tucson, the number of active listings numbered a seasonally adjusted 6700 in April, down from over 10,000 at the April 2007 cycle peak. In metro Phoenix, listings have declined from January 2008’s high of almost 59,000 to 49,500 in March. The number of months supply, which compares the number of listings to the sales rate, now stands at 8.9 months in Tucson and 7.8 in Phoenix. Peaks for these measures, which came at the end of 2007, registered 10.4 and 15.7 months, respectively. Normal supply is five months (Exhibit 4).
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Falling employment and credit market turmoil has taken a toll on commercial real estate markets. Vacancies are now soaring as businesses close and new construction is evaporating, according to CB Richard Ellis. In metro Phoenix, office vacancies rose to 22.8% in the first quarter, up from 17.5% one year ago. Net absorption is negative and only 2.6 million square feet are under construction. Industrial vacancies stand at 14.5% compared with 9.8% one year ago. Absorption was negative 2.8 million square feet and only 2.9 million square feet was under construction at the end of the first quarter, down from 9.3 million. Retail vacancies rose to 9.7% from 6.5% the prior year. Only 3.1 million square feet was under construction, compared to 7 million one year earlier. Absorption of retail space was negative 790,000 square feet during the quarter.
Although the Tucson market is also feeling the effects of recession, the situation is considerably brighter. Office vacancies were 14.9% at year end, up 2.3 points in a year. Industrial vacancies end the year at 6.7%, up from 5.3%, and shopping center vacancies rose to 9.1%, compared to 7.4%. Retail absorption was positive 941,000 square feet during 2008, and 562,000 square feet was under construction at year end. Comparable numbers for industrial were 766,000 and 1.1 million square feet, respectively. Absorption in offices was negative 93,000 square feet, and only 42,000 square feet were under construction.
Business capital spending on buildings is expected to remain depressed at least through the end of 2010.
The Outlook
Even with the current crop of dismal data covering the first quarter, we continue to expect that recession’s grip to loosen in coming weeks, the economy to stabilize, and then begin a gradual recovery. Losses in nonfarm employment statewide will moderate but not bottom until the first half of next year. Part of the reason for that are large layoffs in the public sector (schools, state and local governments, and universities) that are just now beginning and the coming shake-out in commercial real estate. It will be 2013 before employment losses economy-wide are recovered and a new expansion can begin.
The recession is much deeper in metro Phoenix than in metro Tucson. Nonfarm employment will decline by 6.1% this year in Phoenix, compared to -4.1% in Tucson. Retail sales this year will show declines of 7.0% and 3.4%, respectively. Personal income will decline by 1.9% in Phoenix but hold steady in Tucson.
Hopefully by next quarter the data for Arizona will begin to reveal that a bottom is beginning to form. 
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