Still Looking for the Bottom

Marshall J. Vest
Forecasting Project Director

September 1, 2008

Recession continues to grip Arizona and several more months are likely to pass before the economy bottoms and then begins to recover.  By the middle of 2009, housing markets should bottom, credit will once again be expanding, and consumers
will begin to release some pent-up demand.  The business cycle will turn up and
by mid-2010, robust growth will return once again.  In our annual update of
the long-term forecast, we find abundant growth in Arizona’s future. 
Some 15 million people will call Arizona home in the year 2040,
which may boost the state into the top five most populous.   

Recent evidence shows that Arizona’s economy continued to contract in the second quarter with little prospect for recovery in the near term.  The financial crisis continues to deepen, housing markets continue to swoon, consumers are in full retreat, jobs are disappearing, inflation is accelerating, and wages are stagnating.  Nonresidential construction, which provided support earlier as housing collapsed, is now headed downward as well vis-à-vis rising vacancies and restrictive credit.  State and local governments are struggling to balance budgets, which are heavily reliant on sales taxes.

Exports have been a bright spot, but its effect is too small to offset losses in the broader economy.  So too with the copper mining industry, which has added jobs at double-digit annual rates in the past two years, but the numbers of jobs total less than a few thousand.  In the manufacturing industry, increased exports have not added to payrolls.  In fact, manufacturing employment has fallen by nearly 10,000 statewide over the past two years.  Meanwhile, over 50,000 construction jobs have been lost.
 
Consumer sentiment recently plunged to recession levels because of job losses, falling wealth from lower home prices and stock market losses, much tighter credit availability, and high food and energy prices.   Consumers have trimmed spending to levels the likes of which haven’t been seen since the 1981-82 recession.  At mid year, retail sales statewide were declining at a 5.5% annual rate and were down 7.6% from the February 2007 peak.  In inflation-adjusted terms, the declines are in excess of 10 percent.  The largest declines during the past year have been in auto sales (down 24%) and furniture stores (down 10%). 

On a positive note, home sales and residential construction show signs of stabilizing.  After seasonal adjustment, residential building permits statewide have held steady near a 30,000 annual pace (of which 22,000 are single family).  This represents a decline of 70% from peak activity in October 2005, on par with the declines experienced in the mid-1970s and early-1980s recessions.  Clearly, the lion’s share of this correction is now behind us.  Home sales have stabilized in metro Tucson but have actually moved up in metro Phoenix in recent months!  Some 40-50% of sales are repossessed houses, which continue to flood the market, but they are being sold to investors willing to take the long view.

Inventories of for-sale homes also are dropping in both markets, and the number of months supply has dropped to around 10.  Normal is four to six.  The excess supply continues to put downward pressure on housing prices, although it’s hard to measure the impact.  Two ”repeat sales” indexes for metro Phoenix show widely disparate results: Standard and Poor’s Case-Shiller index has fallen some 32.6% over the past two years (data through June) while the OFHEO measure is down only 12% from its fourth quarter 2006 peak.  It’s important to realize that both are simply small samples of the existing housing stock and each measures a different market segment.  Neither is representative of housing prices in your neighborhood and prices vary significantly from neighborhood to neighborhood.

The overall economy won’t launch much of a recovery until credit markets loosen and construction activity moves up.  The best bet is the end of this year at the earliest and most likely the middle of 2009.  That will set the stage for the next expansion which should carry through the middle of the next decade.  Exhibit 1 beloe for a summary of the near term forecast.

Long Term Outlook

Official estimates from the U.S. Census Bureau show that Arizona was the 16th largest state as of July 1, 2007, with a population of 6.4 million.  Indiana’s population count was greater by only 6,500.  The addition of an estimated 135,000 during the past year vaults Arizona past Indiana, Massachusetts, and Washington into the 13th spot.
During the first seven years of this decade, Arizona’s population grew by 22.7% (according to Census Bureau estimates).  The addition of nearly 1.2 million residents accounts for fully 6% of the nation-wide gain.  Only Texas, California, Florida, and Georgia added more people. 

Arizona’s growth is expected to continue at a rapid pace.  In an annual update of our 30-year projections, we show Arizona’s population reaching 14.9 million in the year 2040.  That’s eight-and-a-half million more people than currently call Arizona home.  In short, Arizona’s population is expected to more than double in the next 30 years, and Arizona may well become the fifth largest state in the U.S., trailing only California, Texas, New York, and Florida.

Projections from the Census Bureau show Arizona at 10.7 million in 2030.  Our number is one million higher at 11.8 million. Projections for each 10-year interval for selected aggregate measures are presented in Exhibit 1.

Exhibit 1: Projections to 2040, Arizona

Highlights of the 30-year forecast

• The number of jobs in Arizona will more than double over the next 32 years as 3.7 million new jobs will be created, boosting the total to 6.3 million.
• Arizona’s employment to population ratio will remain below its peak established in 2000 (43.4%) and after dipping to near 38% in 2010, finishes in 2040 at 42.5%.  Arizona’s ratio consistently runs about 3-4 points lower than nationwide.
• Per capita personal income relative to the nation continues its downward slide from 85% today to nearer 80% 30 years from now.  This ratio peaked at 96% in 1981 and will dip below 78% during this recession (Exhibit 2).

Exhibit 2: 30-Year Slide Will Stabilize
Per Capita Personal Income
Arizona as % of U.S.

• As the population continues to age, an increasing share of personal income will come from transfer payments, of which social security is the largest component.  The share will rise from 17% today to 23.4% by 2040.  Per capita transfers in Arizona however remain steady at 90% of the corresponding nationwide measure, so Arizona is mirroring national trends.

• Retail sales relative to income will continue to fall, dropping to less than 20% from over 40% in the mid-1960s.  An aging population that spends more on services (especially health care) and a smaller portion on goods accounts for the drop.
• Migration flows will continue to account for the lion’s share of population growth.  On average, natural increase (births minus deaths) accounts for one-third while net migration provides the remainder.  The latter varies significantly, of course, over the business cycle.
• The annual number of net migrants continues its upward trend to reach nearly 230,000 per year in 2040, compared to 180,000 in 2005.  As a percent of the standing population, net migration falls from 3% in 2005 to 1.5% in 2040 (Exhibit 3).  

Exhibit 3: Migration Overshadows Natural Increase
Components of population
Annual change, Arizona

Arizona has been the second-fastest growing state over the past several decades, and is expected to continue riding the crest for at least the next few decades.  Over the next 30 years, Arizona will more than double in size.  We can only guess what Arizona will be like, but it’s clear that a great deal of change lies ahead.  Much remains to be determined.  Will Arizona be a leader in the industries of the future, or become an economic backwater?  Politically, will it remain a red state or shift to blue?  Will Arizona still be the low cost leader?  Will it become an exclusive place to live or be the Ellis Island of the Southwest?  Only time will tell.