Guest commentary by Christopher Mier, Chief Strategist and Economist, Loop Capital Markets
We enter the final two months of 2013 with greater uncertainty about the strength of the economy than we have had all year. Given the budget and debt ceiling re-do scheduled for early next year, prospects for the U.S. economy appear less bright. Spirits among economists are low – even for economists. The operating assumption is that the economy has taken a fairly strong hit from the last Congressional misadventure.
What solid clues can we get about the current state of the economy and what it means when assessing municipal credit quality?
The announcement from the October 30 Federal Open Market Committee (FOMC) meeting spoke of “hints of growing underlying strength in the economy,” but the factors that could be driving that strength are unclear.
The ability to experience revenue growth despite economic headwinds is at the crux of state credit quality-now more than ever given the chronic budgetary stress facing state governments.
The housing market, an important driver of economic activity over the last few years, is sustaining growth in home prices month-over-month, but is showing signs of slowing. Payroll growth has decelerated to an uncomfortably low rate of growth over the past four months, and is now at a level insufficient to drive the unemployment rate any lower. What will sustain the economy and provide this underlying strength amid continued fiscal drag, a change in Fed leadership, and budget and debt ceiling in-fighting?
The Aruoba-Diebold-Scotti Business Conditions (ADS) Index may provide some clues. This “real time” index, prepared by the Philadelphia Fed, is updated as each new component of the seven-part index is released, thus making it a real time indicator. In truth, only an economist would regard this as “real time”, but it provides very valuable information intra-month, unlike the majority of the monthly indictors used to measure the performance of the economy.
The 15 “accelerators” are an interesting patchwork of states with varied economic profiles …
The ADS index has been uncanny in its ability to keep investors out of trouble. Remember the “spring swoons” that were so widely anticipated in 2011 and 2012 – the swoons that didn’t happen (at least not to the degree anticipated)? The ADS reflected the weakness in the economy without exaggerating the risk of recession. So what is ADS saying now? The current index suggests that we side with the Fed, not the private sector economists. There is no apparent impact recorded – at least yet – from the recent Congressional malpractice.
According to the ADS index, the economy is continuing to proceed at a “trend” rate of growth – an encouraging deviation from the downbeat tone surrounding most appraisals of the economy.
Variation Among States
The performance of individual states can be widely divergent from the national average. The most recent data, published in the October edition of the Quarterly Appraisal of State Economic Conditions, issued by the State and Local Finance Initiative, reveals that 44 states have positive 3-month changes in their coincident economic indicators-a sign that growth continues to be broad-based across most of the country.
A closer look, however, shows that the 3-month change is greater than the 1-year change in only 15 states, which we’ve termed “accelerators.” While economic growth remains broad-based, it is actually weaker now than over the past year for the majority of states. With the exception of the 15 accelerators, the nation’s economy is growing, albeit at a decelerating rate. This statistic helps resolve some of the apparent conflict between the more optimistic growth the Fed anticipates, and the growing concern that private sector economists are currently expressing.
ACCELRATION OF 3-MO V 1-YR COINCIDENT INDEX
The 15 “accelerators” are an interesting patchwork of states with varied economic profiles, including resource-rich states like Wyoming, North Dakota, Louisiana, and South Dakota – but curiously, not Texas or Oklahoma. In the case of Texas, the 3-month change in the coincident indicator is just slightly below the U.S. rate. Oklahoma is experiencing an outright decline in their 3-month change.
Interestingly, the “accelerators” include a solid representation of traditional manufacturing states, like Wisconsin, Ohio, and Illinois. Agricultural states with a heavy dose of manufacturing – such as Minnesota and Indiana – also appear on the list.
The Sun Belt is represented by Florida, Arizona, and Hawaii (a quasi-“Sun Belt” state). Considering that Maine, New Hampshire, and Mississippi are also accelerating, the small group of states that are improving over the last quarter relative to the last year is an eclectic group that imply the presence of multiple economic drivers currently impacting the economy nationwide, but in varying degrees in the different regions.
In order to draw the important connection between the pace of economic growth and the pace of revenue growth, we can take the 1-year growth in total state tax revenues and compare it to the 1-year change in the coincident indicator for all 50 states.
The accompanying table provides a solid visual relationship between better growth in the coincident indicator for a given state with better revenue growth for that state.
The ability to experience revenue growth despite economic headwinds is at the crux of state credit quality-now more than ever given the chronic budgetary stress facing state governments. Furthermore, the states that appear the farthest “north” in this chart, which compares changes in the coincident indicator to changes in revenue, are currently experiencing greater productivity in extracting revenue growth from their given level of economic growth. This efficiency is important given the slow rate of growth in the economy during the course of the recovery and the likelihood that growth will continue on this so called “new normal,” sub-optimal growth track.
The three highest “stars” in the current fiscal night sky are California, Delaware, and Nebraska. These states are about as disparate a group as one could assemble: California, a first-world nation in its own right; Delaware, a small manufacturing state past its prime; and Nebraska, an agricultural powerhouse with a small population and a touch of manufacturing. This kernel of information is packed with an important observation, though. As the recovery rolls and tumbles through the nation via changing industry groups and geographically, the more successful mega-economies of California and Texas, along with the agricultural states and the manufacturing states, have performed well. The key is recognizing that the pistons are not all firing all at the same time, and that the current “high flyers” will likely give way to a new set of stronger performers.
While the current data is obscured by the economic impacts of the recent government shutdown and debt ceiling incidents, plus the literal delay in the generation of data by the Washington data mills, the nation’s economy continues to perform well enough overall thanks to the currents of warm water supplied by agriculture, resource extraction, manufacturing, and the highly integrated mega-economies (like Texas and California).
Identifying which states are expected to experience slightly better economic growth spurts, along with the resulting stronger tax revenue, can be a valuable first step along the road to assessing state and local municipal bond credit quality.
Disclaimer: The opinions and statements expressed in this column are solely those of the author and Loop Capital Markets, who are solely responsible for the accuracy and completeness of this column. This column does not reflect the position or views of RICIC, LLC or MuniNetGuide.
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