Economy Nearing the Top – 4 Indicators to Watch

Recently, there have been several signs that we’re nearing the top of the economic cycle. Here are four indicators that the economy is reaching its peak and three things to consider to prepare for the downturn whenever it happens.

Real estate values

Real estate values around the country and here in Nashville in particular are skyrocketing. Both residential and commercial space is increasing in value at an incredible rate but warning signs are starting to appear. The leading topic of conversation here is “do you see any end in sight” to the real estate growth?

At our recent ACG-Tennessee meeting, a panel of Nashville real estate development experts discussed several trends that spell trouble. All feel that by 2019 the bubble will deflate somewhat. Specifically:

• Building material prices are starting to rapidly increase. An executive with Highlands Properties was told his sheet rock cost would increase 18% next year alone. Other materials are costing more too.
• Per square foot rents going up double digits each year. Nashville’s growth and popularity have overcome these increases but this won’t continue.
• The rate of development, price increases and values are unsustainable according to the panel

Additionally, I’ve read and posted several articles on LinkedIn that show that the average income is many metropolitan areas is stagnant and the average price of homes is rapidly increasing, meaning that homes are becoming more un-affordable for a majority of people. California and New York are the worst areas but Nashville’s average home price is 5.1 times more than its average income, the highest discrepancy ever.

Finally, the Case-Schiller index, probably the most respected measurement of real estate activity and values, shows that prices new exceed the pre-Great Recession levels, which was our last real estate bubble.

Business and personal debt

To keep this article from becoming an encyclopedia, here are three concerning facts that have been written about recently. For specific articles to support these points, visit my LinkedIn page. They’ve all been posted over the last few months.

1. Corporate debt is higher now than before last recession. After de-leveraging in 2009-2011, companies have taken advantage of artificially low interest rates to load up on debt. (This doesn’t include another worrisome issue – the derivative exposure our largest financial institutions are holding).
2. Loan officer survey indicates tightening in certain sectors of lending (auto finance for instance).
3. Personal debt has reached record levels.

Auto industry has peaked

Like housing, the auto industry has a multiplier effect on our economy. Coming out of the Great Recession, pent-up demand for replacement vehicles created huge sales increases and a time of prosperity for the auto industry. There are signs that this is beginning to slow.

The heavy use of financial incentives has helped auto sales continue to grow after the initial wave of replacements immediately after the recession. Inevitably, as more consumers replaced their cars and trucks, manufacturers began to “sweeten the pot” to spur more buying by extending and increasing incentives.

Those incentives have run the course and are no longer driving sales increases. In fact, auto sales have peaked and slightly declined while loan defaults have increased. Lenders have begun to tighten credit standards for the “sub-prime” sector of the auto finance business. As one article said, “any time someone with a 520 credit score can buy a $75,000 Escalade and finance it for 84 months, sooner or later, you’re going to have a problem.” Now is that time.

Trend toward longer terms of sale

The last indicator is a personal observation. I’ve had a growing number of requests from my own clients to extend longer invoice terms to key clients. While longer terms is a general trend as large corporations treat their smaller suppliers like a bank, recently the trend seems to be spiking.

Terms of 90 to 210 days are being requested lately. This tells me cash flow is going to be tightening and buyers are stretching suppliers more than usual.

HOW TO PREPARE FOR DECLINE

There are three things businesses can do now to prepare for the next recession.

1. At the risk of “tooting my own horn”, buying a credit insurance policy to protect cash flow and safeguard a business’s largest asset is a very good idea. Getting ahead of a recession is the first reason to move on credit insurance now. Other reasons include the value in knowing who to safely extend credit and who to avoid heading into a downtown. Finally, using credit insurance to help with bank financing and operating efficiency is valuable in a tightening economic cycle.
2. Be more thorough in evaluating customer credit worthiness. With or without credit insurance to help analyze and monitor the customer’s financial condition, all businesses should be more careful in monitoring credit. Take some time to analyze the financial condition or your customers and don’t assume they’re all in good financial condition.
3. Conduct a ratio analysis of your business (hire a consultant if needed). Stay as liquid as possible (cash is king) and know your cash conversion cycle, the time in your business cycle when cash is paid out versus taken in. Do what you can to shorten the cycle by looking to better manage payables and receivables. Your ratio analysis will tell you how your own business is performing and will measure your liquidity, profitability and efficiency.

Conclusion

By becoming aware of your surroundings and taking some basic precautions, each business can prepare for the inevitable economic downtown while there’s still time. Although there are plenty of positive signs being reported every day, there are also some warning signs and we should all pay attention to avoid as much pain as possible.