Fall 2016 Linneman Associates Capital Markets Webinar Transcript Sample

Fall 2016 Linneman Associates

Capital Markets Webinar

Dr. Peter Linneman, CEO

Linneman Associates

Moderated by Bruce Kirsch, CEO

Real Estate Financial Modeling

November 29, 2016

Copyright (c) 2016 by Linneman Associates. Reproduction permitted only with proper attribution.

Global Economic Outlook Web Conference Transcript November 29, 2016

Linneman Associates Page 1

Bruce Kirsch

Good afternoon everyone, this is Bruce Kirsch, Founder and CEO of Real Estate Financial Modeling. We are very pleased to have a terrific webinar for you today. This is the fall 2016 Linneman Associates Capital Markets webinar. I would like to introduce Dr. Peter Linneman.

Dr. Peter Linneman

Thank you very much. One thing you left out of the introduction is that you were a very good former student of mine, you’ve helped a lot with the book, and you have also been a great friend. We will start with the first chart, which says Cumulative Percent Increase in Real GDP. It tracks the increase in GDP over the recoveries after the six post-WWII recessions. You’ll notice that this recovery is at the bottom and has lagged all previous GDP recoveries. It has been a slow, long recovery, which is abnormal because typically the deeper the recession, the faster the recovery. Secondly, you’ll notice that not all recoveries turn down after the same number of quarters. Not all recoveries have the same lifespan. Two of the recoveries, marked in red and orange, already started a GDP decline at this point in the recovery, while in the other recoveries, GDP continued moving up smartly at this point in the recovery. The notion that this is an old recovery doesn’t hold much relevance.

Moving to the next slide, you will find the Economic Policy Uncertainty Index. It is believed that when the rules of the game are known and stable, there is higher growth. When they are unstable and unknown, growth is lower. The red line shows the average, and the blue shows where we are at now. We had a lot of political uncertainty in the late 1990s and again right after 9/11. We had low uncertainty and high growth in the early 2000s, then we had this abnormal period of high uncertainty, which relates to that long period of slow growth as opposed to robust growth. If you don’t know the rules of the game, it’s very difficult. We’ve normalized a lot in the last few years but gained more volatility leading up to the election, which is not surprising to see. This data is not updated to include post-election, but this is going to be high for a month or two until people have a sense of who is on board, what is being done, what the priorities will be, and so forth. On the other hand, the fact that we are down from this high period of uncertainty is good for the economy.

If you go to the next chart, you see real GDP year-over-year percentage growth. You can see that we had GDP growth averaging 1.5-2.3% per annum, which is adequate but not great, and well below its historic norm. You can also see how steep the decline was during the recession, in 2009 and 2010. It was a very deep recession in terms of the drop in GDP. Moving to the next chart, I mentioned that we are getting 1.5-2.5% annual growth, but the long-term historic norm is closer to 3%, which is comprised roughly of 2% productivity growth per year, of those already here, and about 90 basis points of population growth. You’ll see that the long-




term trend I have on this chart extends from 1969 to 2007. However, I’ve done a similar chart that goes back to 1800, and it doesn’t look very different. The blue line is real GDP, meaning adjusted for inflation. It is at an all-time high, as it has risen from its drop, and it is the highest on a per capita basis that it has ever been. So in that sense, the economy is doing better than it has ever done.

But the malaise – the feeling that something is wrong – is that there is a $3 trillion gap on a $19 trillion economy. There’s a $3 trillion gap between where we are and where we should be. It’s a little bit like if you’re on an expressway and used to going 65-70 miles/hour, but traffic is only letting you go 40 miles/hour. It is not as if 40 miles/hour is slow, and traffic is still moving along at a decent pace, but it is not going as fast as you think it should be. This gap amounts to six or seven thousand dollars per person, which is very significant. About half of the gap is related to the sluggish and abnormally slow recovery in the housing sector, in particular the single-family housing sector, which employs a lot of middle class workers (e.g. title insurance, construction). This gap is largely due to housing and related activities, and it raises the question of why single family housing has been so slow. If you understand why, you have a better grasp of where we are and what is needed to have a more robust and continuing recovery.

The next chart just shows Actual versus Trend GDP, the two lines shown on the previous graph. This chart expresses it as a percent of GDP rather than an absolute number. Going back to 1880, we have had many times when we were above trends and many when we were below, but we have always reversed the trend historically. However, the Great Depression was a deviation, and it took 40 years to close the deviation, despite people thinking it would never reverse. I believe that a lot of market regulations, interventions, and distortions are responsible for the gap, which is 14.2% of GDP.

Also responsible is a Fed that has artificially set interest rates near zero and killed the economy. Low prices set by the government, outside the market, do not encourage economic activity. For example, we have about $2.1 trillion in excess cash being held versus the long-term trend because at a zero percent interest rate, there is no opportunity cost to holding cash and people are not going to invest in a 10% risk investment for a 4% return, so they sit on cash. Cash does not create a lot of jobs or GDP growth, and in fact, if you took the $2.1 trillion in excess cash out, that occurs right as interest rates plunge. In fact, the growth in excess cash is right in line with what you would predict to happen when interest rates are kept that low for that long. This excess cash amounts to about 90 basis points of GDP being lost. If instead this were invested at an 8% rate of return, it would generate about 90 basis points of GDP today, and this number is growing over time.

Interest rates are just a price. If you set a price artificially at zero, a lot of lenders cannot find good loans or good borrowers. The second part of it is that if you believe low interest rates




are a good thing, then set oil prices to zero, steel prices to zero, and all the rents in the economy to zero to stimulate demand. That would be crazy. You do not stimulate demand by setting prices artificially low, but rather by letting the market have some general direction in determining supply and demand. If you set prices at zero, you have a lot of people who want it but few who will produce it. We’re sitting on a lot of cash that people want, but that few are willing to provide, which is creating this gap.

We’ll next take a look at the labor market. You can see that the unemployment rate for youth, including part time workers, skyrocketed during the recession and has since come down pretty much in line with the norm at this point. The overall unemployment rate is down at 4.9%; it’s gotten lower but it looks fairly healthy. Moving to the next chart, you can see the employment-to-working age population ratio, which used to be low but rose as women entered the labor market and as baby boomers aged; but then it plummeted during the recession. Over the last few years it has crawled back up, but it is still pretty low. Part of the reason why it’s still low is that millennials are still in high school and college, not in the labor market. Millennials are a big population group, so that is pulling the ratio down, but there are also still a lot of people sitting on the bench. Many of them are in their 50s and 60s, and when the bad times happen they declare themselves disabled in order to qualify for disability. While they don’t live well, they live well enough for them and are therefore unlikely to come off the bench. This ratio will stay low for a while, but as the millennials come into the labor force, it will rise.

If we take a look at this next chart one will get another view of the labor market. This shows weekly unemployment insurance claims, which is a real time and very accurate number. The red line indicates the average since 1967. Basically, whenever it is below 300,000, it signals a good labor market. Currently, we are down to approximately 250,000 weekly initial unemployment insurance claims, which is quite strong. This is a weekly indicator that I frequently tweet about, and the underlying data is quite readily available. When it rises, it does so quite rapidly. If it rises very quickly within a 3-month period, then it is time to be concerned. However, at the moment, this indicator reveals the labor market to be quite good, and it is consistent with real wages rising.

This graph on the percent of people unemployed by duration provides another look at the labor market. It is the ratio between transitional unemployment and long-term unemployment; those returning to work within 5 weeks to those who remain unemployed for longer than 26 weeks. One would like to see this trending upward, which means lots of transitional unemployment and relatively very little long-term unemployment. You can observe that this plummeted during the recession. It is now coming back, and the duration in unemployment is falling. However, it is still not quite back to normal, as it remains below the


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GDP from Start of Recovery: Remains

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Business

Fall 2016 Linneman Associates Capital Markets Webinar Transcript Sample