Recovery is slow for area businesses

More than two years into a technical economic recovery, just over half of all businesses surveyed in Fairfield County (53%) are profitable. While most believe conditions for their companies will either remain stable (40%) or improve (38%), they are far less confident about the economic outlook for Fairfield County as a whole.
Those are some of the overall findings of a survey released today at the CBIA/Stamford Chamber of Commerce Economic Outlook luncheon.

The biennial Fairfield County Business Survey exam­ined the workforce, energy, and transportation challenges for companies in Fairfield County and the economic, financial, and regulatory climates in which they operate. The survey was emailed to approximately 3,000 businesses; 195 completed the survey, for a response rate of 6.5%.

Key findings:

• Business profitability was clobbered by the recession. Though most businesses (84%) were profitable immedi­ately before the recession, only 46% turned a profit during the recession.

• Profitability saw only modest improvement over the last two years. An upswing in 2010 (60% of respondents recorded a net profit) was tempered by a dip this year (only 53% expect to be profitable in 2011).

• Nearly half of all respondents (48%) report that skilled work­ers are not readily—or at all—available in Fairfield County. This is a sharp increase over 2009, when 22% said skilled workers were not readily or at all available. Despite a statewide unemployment rate hovering around 9%, only 39% of respondents today say Fairfield County has a sufficient number of skilled/educated workers. In fact, more than one in ten businesses surveyed said a labor shortage is preventing them from expanding.

• Only 18% expect any improvement in the economic outlook for Fairfield County in 2012; 44% expect conditions over the next year to get worse.

• While many firms are on track for growth, a sizable minority are struggling: 24% are in the red this year, and 23% expect conditions to deteriorate further in 2012.

• Nearly one-third of businesses surveyed (31%) plan to expand in the next five years; another 13% recently expanded. The biggest barrier to expansion, noted by more than half of businesses (51%), is the cost of doing business—including taxes and regulations.

• Only 15% of respondents today (compared to 43% two years ago) agree or strongly agree that their state and local taxes are reasonable, and nearly three-quarters (74%) be­lieve government makes it harder for their companies to succeed.

• When asked in 2009 to predict the single greatest challenge to operating a business in Fairfield County over the next five years, nearly 20% of businesses surveyed identified problems with the region’s transportation infrastructure. Forty-three per­cent of respondents then—and now—said the most effective action state government could take to address the issues would be improving I-95 and expanding highway capacity by adding lanes. Expanding the rail system was also a top choice.

This year’s survey and Economic Outlook were sponsored by BlumShapiro and TD Bank. The luncheon featured top business and economic experts, including Christine Cumming, first vice president and chief operating officer of the Federal Reserve Bank of New York, discussing the Connecticut, New York, and New Jersey economies.

Only half of Fairfield County’s businesses expect to be profitable this year, as the region’s economy slowed amid concerns about the national economy, transportation infrastructure, and operating costs, according to a survey released today.

The 2011 Fairfield County Business Survey, published by the Connecticut Business & Industry Association and the Stamford Chamber of Commerce, in partnership with BlumShapiro and TD Bank, identifies issues and trends within the region’s economic, fiscal, and regulatory climates.

Just 53 percent of those surveyed expected to turn a profit in 2011, against 60 percent who were profitable in 2010. Those figures compare with the 84 percent of the region’s businesses who were profitable in 2007, prior to the recession.

While many firms are on track for growth, a sizeable minority continue to struggle. One-quarter of those business that responded to the biennial survey were in the red this year, while 23 percent expected economic conditions to worsen in 2012.

“We were hopeful that 2011 was going to be the year of growth,” said Jack Condlin, president and CEO of the Stamford Chamber of Commerce. “The first half was encouraging, but the third quarter took the wind out of our sails.”

[See the complete 2011 Fairfield County Business Survey (pdf)]

Almost a third (31 percent) of those surveyed plan on expanding their businesses. However, more than half said the costs of doing business–including taxes and regulations–was the greatest obstacle to expansion (see image above).

“Considering that we are over two years into a ‘technical’ economic recovery, these figures reflect an economy that is still stressed,” said Pete Gioia, CBIA economist and vice president.

Other key survey findings:

• Though most companies surveyed (72%) have no direct ties to the financial services sector, more than three-quarters (76%) acknowledge the sector’s importance to the region’s economy.
• Nearly half of respondents (48%) reported that skilled workers were not readily available in Fairfield County, a sharp increase over 2009 (22 percent).
• Improvements to and expansion of I-95 were identified as the best solutions to the region’s transportation problems.
• Fairfield County’s traditional strengths—its quality of life and prime market location—continued to shine as the greatest benefit for businesses to operate in the region.

While Fairfield County business leaders believe government often makes it more difficult for them to succeed and are not convinced that their state tax dollars are used effectively, they also believe that there are opportunities for the public sector to help the region be more competitive.

For example, they believe policies that reduce business costs, increase the availability of skilled workers, and result in transportation improvements and better access to capital would greatly benefit businesses in the region.

“This survey shows that there are a lot of areas where Connecticut policymakers can take action to lower the cost of doing business, improve infrastructure, and instill the confidence that businesses need,” said CBIA’s Gioia.

”The October 26 special General Assembly session gives them a forum to initiate positive change.”

We have seen some pretty interesting developments on the national economy during the last month, most notably the new initiative from the Federal Reserve regarding quantitative easing, which is known as QE2. Economists are somewhat divided on the initiative to pump another $600 billion into the financial system, asking whether the benefits are apt to be outweighed by the downside risks of much higher inflation.

I think the Fed’s rationale behind QE2, at first glance, makes sense. In light of the fact that the benefits from the $787 billion stimulus are now tapering off, and that state and local budgets look to be under considerable pressure for the next several years, it is pretty clear that fiscal policy, across board, will be restricting the aggregate economy. Voters have made it clear that fiscal discipline is now a priority and that cuts in state and local spending are in the offing. With that as a backdrop, it makes sense for the Fed to opt for every available financial tool in helping us avoid the dreaded “double-dip” recession. Hence, the logic for QE2 can be defended.

Mark Zandi, Chief Economist for Moody’s Analytics, the nation’s top economist whom I have known and respected for years, was in town several weeks ago discussing the prospects for U.S. economic growth. His read is that the next 6-12 months are apt to be difficult, but that we are likely to slip by with slower, but positive growth, avoiding another recession. His read is that we will be helped in part by QE2, which is aimed at reducing interest rates on the long end of the yield curve. By doing so, it is hoped that mortgage holders and business borrowers can refinance existing debt at more favorable rates, freeing up discretionary income that helps spur consumption and business activity. That makes sense. Moreover, it is hoped that by making capital more affordable, businesses theoretically can step up hiring, and move us that much more quickly into the growth phase of the business cycle when firms start adding workers. Lastly, QE2 stands to help our export sector by making US manufactured goods that much more affordable to our trading partners by promoting a lower US dollar.

However, this new QE2 initiative from the Fed also carries some risks, too. By injecting another $600 billion into the financial system at a time when many central banks are increasing interest rates, it raises the risk of a currency war when other economies- China, India, Germany, Japan, and others – are also trying to add new jobs. Today it appears that we have little political will in tackling our overspending problem at the national level, and therefore monetary policy, as opposed to fiscal policy, will need to do the heavy lifting in promoting recovery. Therefore, the Fed’s move to borrow $600 billion from the US treasury to buy Treasury bonds, which will bid up bond prices, but drop yields, is probably one of the few options we have left.

But what are the tradeoffs and implications? With reduced rates of return, it begs the question: In a global economy where money always seeks its highest perceived rate of return, will foreign investors, whom we are primarily reliant on for financing much of our debt (note: 38 cents out of every federal dollar spent is now borrowed! Wow!) start opting for other global investment alternatives, shunning dollar-denominated assets, such as US Treasuries. The US simply isn’t the only financial game in town anymore! Or, more specifically, what happens to our prospects for economic growth if and when China stops buying US treasuries? Not a fun thing to contemplate!

By reducing the value of the US dollar, our purchasing power in the global marketplace declines, and the prospects for rising inflation become real and tangible. This also potentially means that the quality of life for future generations could be adversely impacted by a lower dollar policy, if overdone.

My greatest concern? The lower dollar poses a specific risk to us here in New England in that there is an increased risk of another oil shock. Oil could easily top $100 barrel in the next year!  Imported oil is poised to become more expensive in coming months because the transaction is made in US dollars. Therefore, because we heat our homes with oil, and because we generally drive farther to work, the risk of a lower dollar means that our energy costs could very well be rising against the backdrop where China and India are industrializing their economies and stepping up oil demand. This could reduce our long-term competitiveness as a region. A lower dollar also means that US assets here can be purchased at cheaper prices, just as Dubai did several years ago when it bought a chunk of the NASDAQ stock market. It raises the potential for foreign concerns to buy US assets here and have a greater say as to the policy initiatives. Bottom line: in the long run, a precipitous drop in the dollar means we have less control over our own economic future when foreigners start buying our assets on the cheap: real estate, companies, you name it! Not a pleasant alternative in my mind!

Lastly, many are excited that QE2 and lower interest rates means higher stock prices over the long run. I say not so fast! The Fed Model for assessing fair market value in the stock market, created by Alan Greenspan and Ed Yardeni, says that fair market value on the S&P 500 is a function of earnings per share on the S&P 500 divided by the yield on the 10-year government bond. If bond yields drop, then stock prices theoretically should rise. That’s true. But it is my belief that a run up in stock prices IS NOT SUSTAINABLE WITHOUT TANGIBLE IMPROVEMENT IN EARNINGS. Therefore, stocks gains will not be sustained without earnings growth, improved employment gains, and overall economic growth supporting it. We know it is NOT just about interest rates as rates have declined to record lows, but we still are looking at 1.7% real GDP growth and unemployment nearing 10 percent!

Economist John Hussman put it well this week when he stated the following: “At present, investors and analysts who focus on simple price/earnings multiples are placing themselves at tremendous risk, because simple P/E multiples are being distorted by unusually wide profit margins. Part of this can be traced to weak employment conditions, which have held down wages and salaries. But there is more to the story – the rebound in profit margins also reflects a heavy contribution from financials, which may be more indicative of accounting factors than sustainable earnings, as well as the tail-end of stimulus spending”.

In response to QE2, a group of well-respected economists, writers, and investors wrote an open letter to Ben S. Bernanke, the Fed chairman, last week and urged that the Fed’s action “be reconsidered and discontinued,” arguing that the bond purchases “risk currency debasement and inflation.”  To me, it’s a valid concern.
Also, Bill Gross, the world’s top bond fund manager, says “The Fed’s announcement will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment… Check writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. Public debt, actually, has always had a Ponzi-like characteristic”.

Gross has some serious questions about the benefits of QE2, saying that, “We are, as even some Fed Governors now publicly admit, in a “liquidity trap,” where interest rates or trillions in QEII asset purchases may not stimulate borrowing or lending because consumer demand is just not there. Escaping from a liquidity trap may be impossible, much like light trapped in a black hole. Just ask Japan. Ben Bernanke, however, will try – it is, to be honest, all he can do. He can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it is all he can do, and as he proceeds, the dual questions of “will it work” and “will it create a bond market bubble” will be answered. We at PIMCO are not sure.”

Moreover, some economists rightly believe that the Fed is trying to make up for a fiscal policy that is lacking in many ways, and in doing so is losing one their most valuable assets, namely their credibility as an independent entity. Surprisingly, there is no formal oversight of Fed policy here, no formal set of checks and balances, just the Federal Open Market Committee and its Fed Governors trying to make the right moves regarding monetary policy, growth in the money supply, and our economic future. Pretty scary, isn’t it? Politically, the QE2 initiative has been polarizing as Republicans have generally dismissed it as being unnecessary and inflationary, while Democrats often praise the attempt at sidestepping another downturn given weak labor markets. It is also worth mentioning that the Fed generally has less and less influence the farther you go out on the yield curve as market forces take precedent the farther you go out in time. The Fed historically has been responsible for setting short-term rates, letting markets determine longer-term yields. Therefore QE2 represents a clear departure from prior efforts to stimulate the economy, and so many economists are concerned about the Fed’s so called “meddling” and how things are likely to end!

 In sum, in doing my own critical thinking about QE2, I have mixed feelings about the move and some questions. What’s preventing the Fed from doing QE3 or QE4 if the desired effect falls short and what are the impacts there? Can the Fed move quickly enough to curb inflation when it does eventually reignite? Time will tell. The only certainty is that the story line won’t be boring! We’re clearly in uncharted waters on this one!

Don Klepper-Smith, DataCore Partners