How to survive and prosper

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Craft Hobby Association
May 2, 2008
How to survive (and prosper) in this economy
Bernard Baumohl
The Economic Outlook Group, LLC
www.EconomicOutlookGroup.com
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THREE KEY THEMES 1. Where is the U.S. economy
headed? 2. Whats the outlook for consumer
spending? 3. What can retailers and
manufacturers do in this challenging environment?
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The U.S. Economy Are we in recession or
not? Does it really make a difference in
this climate? The recovery will be
(agonizingly) slow.
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Rare Trifecta of Forces Dragging the Economy Down

• Collapse in home sales, prices and
  construction
• Full blown credit crunch
• Cutbacks in consumer and business spending

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Home prices fall more than 12 since January
2007 (SP/Case - Shiller Composite 20 Home Price
Index)
220 200 180 160 140 120 100
Index (2000 100)
2000 2001 2002 2003 2004 2005
2006 2007 2008
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Decline in home prices the last 12
months(February 2008 vs. February 2007)
Source RealtyTrac
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Construction Spending Billions, monthly
annualized

2007
2008
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Housings impact on the economy

• Home construction alone 5 of GDP
• plus related homebuyer purchases (appliances,
  furniture and etc.) 23 of GDP
• Homebuilders hire 11 of total U.S. work force
• Value of real estate owned by households is a
  massive 20 trillion

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Its getting ugly out there!

• U.S. default/foreclosures jumped 112 in IQ 08
  versus year ago.
• One of every 194 homes is in some stage of
  foreclosure
• Nearly 3 million foreclosed properties will be on
  the market in 2008 and 2009
• 8.8 million borrowers are underwater.
• Worst states Nevada 1 out of 54 homes
• California 1 one of 78 homes
• Arizona 1 out of 95
• Florida 1 out of 97 homes

Source RealtyTrac
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CREDIT CRUNCH Who is to blame for the current
mess? ANSWER Just about EVERYONE!
Consumers have been borrowing irresponsibly for
years
Lenders have been doling out money recklessly
-- NINJA mortgages and other loans
Easy money fired up demand for homes from
qualified, unqualified buyers as well as U.S.
and foreign speculators
Investors (hedge funds and investment banks),
frustrated by low yields, were demanding
securities with higher returns
Brokerage firms and banks responded by crafting a
panoply of arcane and complicated securities
backed by subprime mortgages that promised
higher returns.
Rating agencies stamp AAA approval on bonds they
didnt understand
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CREDIT CRUNCH Who is to blame for the current
mess? ANSWER Just about EVERYONE!
MORE.
Regulators ignored warnings of abuses in the
mortgage lending business
Federal Reserve kept short term rates low for too
long
Easy money not only heated up real estate
activity--- but swelled household debt
Homebuilders were constructing houses 50more
than underlying demand
Day of reckoning has arrived!!
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Comparing Losses Where does the latest financial
crises rank?
Costliest natural disaster in U.S. history
Katrina (2005) 80 billion Most
catastrophic attack on U.S. soil 9/11 (2001)
50 billion Losses and writedowns (so far)
from subprime disaster 235
billion IMF projects total cost of subprime
disaster 945 billion!!
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Comparing Losses Where does the latest financial
crises rank?
Costliest natural disaster in U.S. history
Katrina (2005) 80 billion Most
catastrophic attack on U.S. soil 9/11 (2001)
45 billion Losses and writedowns (so far)
from subprime disaster 235
billion IMF projects total cost of subprime
disaster 945 billion!!
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Comparing Losses Where does the latest financial
crises rank?
Costliest natural disaster in U.S. history
Katrina (2005) 80 billion Most
catastrophic attack on U.S. soil 9/11 (2001)
45 billion Losses write downs (so far)
from subprime disaster 312
billion IMF projects total cost of subprime
disaster 945 billion!!
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Comparing Losses Where does the latest financial
crises rank?
Costliest natural disaster in U.S. history
Katrina (2005) 80 billion Most
catastrophic attack on U.S. soil 9/11 (2001)
45 billion Losses write downs (so far)
from subprime disaster 312
billion IMF projects total cost of subprime
disaster 945 billion!!
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Consumers to cutback on spending
Job market is weakening. Household income
not keeping pace with inflation. More
Americans struggle with their debt. Household
wealth is on the decline. Americans feel poorer
now.
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Job market is deteriorating Monthly Change in
Business Payrolls
Thousands of jobs
2008
2006
2007
Source Bureau of Labor Statistics
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Growth in Real Earnings Average Weekly Earnings,
1982 dollars
12-month change
2007
2008
Source Bureau of Labor Statistics
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Gasoline 4.00/gallon within reach The highs
are getting higher AND lows are getting higher
too!
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of total borrowers
1995
1997
1999
2001
2003
2005
2007
Sources Federal Reserve Board (FRB), American
Bankers Association (ABA) 30 days overdue on
credit cards, HE and auto loans
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Households have seen their wealth decline as the
value of their homes and stocks have fallen
Household Net Worth - Yr. end (Trillions)

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Source Federal Reserve
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Consumer Spending Trends Retail Sales, monthly
change

2007
2008
Source Commerce Department
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Please!Is there ANY good news out there?
Great Depression comparisons are nonsense!
Federal Reserve has moved aggressively to stop
financial hemorrhaging in financial sector.
Credit freeze to thaw soon. Business
inventories (outside of real estate) are not
excessive Unemployment not expected to climb
beyond 6. Pent-up demand to buy homes
Inventory of unsold new homes lowest in years!
Home Affordability is the highest in 5
years Growing reluctance by banks to
foreclose Not all regions of the country are
hurting
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Sluggish Economic Growth Ahead
Real GDP, Quarterly
Forecast
Actual
1Q 08
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U. S. Macroeconomic Forecasts
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• What can businesses do in this difficult
  environment?
• Hiring
• Inventories
• Advertising Marketing
• Capital Spending
• Pricing

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Typical Business Cycle Ride
Output (Real GDP)
We are now at this point in the cycle
Peak
Recovery
Expansion
Recession
Recession
Trough
Recovery
Trough
Time
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Understand and use the Business Cycle
to your advantage

Output (Real GDP)
OK to raise prices
Increase capital spending
Do NOT raise prices!
Reduce inventory purchases
Flexible employment strategy
Spend more on ads
Hire skilled workers at trough
Time
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Employment strategies

• At the first signs economy is peaking, enact
  hiring freeze. Supplement workforce with
  temporary staff. Allow attrition.
• As economy slows, introduce a no-layoff policy.
  Prepare incentives to reduce payroll costs (e.g.,
  offer non-pay or partial pay sabbaticals, early
  retirement, flex time, require vacation time).
• Other benefits of no layoff policy
• Prevents competitors from stealing
  your talent.
• Employee morale remains high, which
  lifts productivity.
• Avoids the cost of rehiring and
  retraining workers once the economy recovers.

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Employment Strategies

• Best time to scoop up talent is near recession
  lows.
• You can cherry pick workers with the most skills
  and have maximum leverage setting pay contracts
  pay during downturns.

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Recession is a good time to increase advertising

• Most companies typically slash advertising
  budgets during economic downturns. Smart
  strategy is to the opposite. Your ads will stand
  out. Less noise.
• Ads placed during recessions lead to better brand
  recognition you will be in a better position
  once the economy is growing again.
• Advertising rates are also cheaper during
  recessions.

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Timing Your Capital Spending

• As economic activity gets close to peaking,
  preserve cash flow, hasten accounts receivables
  and reduce capital spending. (Dont wait until
  recession has begun.)
• Increase capital investments once recession is
  underway. Easiest and cheapest time to purchase
  equipment or buy other firms.

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Inventory management

• As economic activity peaks, reduce production and
  inventory purchases.
• Sharply discount poor-selling goods during
  recessions.
• Begin to add inventory as recession hits bottom.

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Pricing during the business cycle

• Key concept
• Elasticity measures how sensitive
  customers are to a change in price.
• LOW elasticity a price increase will have
  LITTLE affect on demand. (Think gasoline, health
  care or a drug addiction.)
• HIGH elasticity an increase in price can
  GREATLY change demand. (Examples travel,
  restaurants, certain foods.)

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Using the business cycle Elasticity can vary
during a business cycle

• Recession elasticity of demand is higher.
• (Consumers are much more sensitive to price
  changes.)
• DO NOT LIFT prices during economic weakness.
• Why? A price hike will be more than offset by
  less demand for that product - and you may lose
  market share.
• DO LOWER prices during an economic downturn.
• Why? Consumers are much more price sensitive
  and value oriented. You may even increase market
  share and brand loyalty.

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Using the business cycle Elasticity can vary
during a business cycle

• During periods of economic strength, price
  elasticity declines.
• OK to lift prices As job and income improves,
  consumers are more tolerant of price increases.
• Good time to lift revenues and accumulate cash
  reserves in preparation for next downturn.

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Best Leading Economic Indicators of Business
Cycle Consumer Spending
Employment Report (www.bls.gov) Weekly Claims
for Unemployment Insurance (www.owsdoleta.gov) Co
nsumer confidence surveys (www.conference-board.o
rg) Real Income Growth (www.bls.gov) Consumer
Durable Goods Spending (www.bea.gov) Household
Net Worth? (www.federalreserve.gov) Consumer
Non-Revolving Loans (www.federalreserve.gov) Re
tail Sales (ex-autos and gasoline)
(www.census.gov) E-commerce Retail Sales
(www.census.gov) Existing Homes Sales and Prices
(www.realtor.org) Capacity Utilization Rates
(www.federalreserve.gov) Major stock indexes -
SP 500
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The Economic Outlook Group
Bernard Baumohl
The Economic Outlook Group, L.L.C. 475 Wall
Street Princeton, New Jersey 08540
[phone]
www.EconomicOutlookGroup.com