Sub-Prime Hit Not A Knockout

October 29, 2007
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GRAND RAPIDS — The national economy will weather the sub-prime storm, but it will be a drag on economic growth for at least the next year.

There’s no reason to expect a quick turnaround, said Mitch Stapley, chief investment officer for Fifth Third Asset Management. He foresees economic growth below 3 percent in 2008. Stapley spoke at the Fifth Third economic luncheon at Meijer Gardens Wednesday about what can be expected now that the contagion in the sub-prime market has spread to other sectors of the financial marketplace. 

Prime borrowers can still get a 30-year mortgage fairly easily, at an interest rate of about 6 1/8 percent, Stapley said. A person with slightly less qualified credit might be able to find a mortgage for around 9 percent. A sub-prime borrower would simply be out of luck: Even if someone agreed to write a mortgage for a sub-prime borrower, the mortgage probably would have an interest rate of about 12 percent, he said.

“People in the sub-prime market can’t refinance their homes, and we’re seeing the impact of that,” Stapley pointed out. “If the problem stays contained to just the mortgage market, we’ll be OK. The issue is what kind of contagion, what kind of kickback do we get?”

The sub-prime contagion has spread to an area that can truly shut the economy down, he said. It shuts down businesses’ ability to borrow, and if they can’t borrow, they probably won’t invest in plant equipment and the inventories they need, and then layoffs follow, he explained. Things are getting better, Stapley noted, but the country isn’t out of the woods yet.

“It all goes back to the real estate market. How soon can the real estate market turn around? I do not support the idea that the real estate market is going to heal itself quickly any time soon,” Stapley predicted.

This is the first time since the Depression that the country has had a national decline in overall home prices, and local markets are experiencing even more of a downturn, Stapley pointed out. In Detroit, for example, home prices have turned down nearly 32 percent from a year ago.

“A couple of things need to happen: We need to have house prices continue to come down or mortgage rates come down more, so normalcy returns to the mortgage market to help bring that affordability measure up,” Stapley explained.

“Until we bring the supply of homes on the market down, there’s really no realistic way home prices are going to rebound quickly. Key to this market turning around is the selling off of the existing home inventory.”

The good news is that there are some fundamental sources of strength. Consumer spending was down 2 percent at the end of the second quarter, but third-quarter data shows consumer spending rebounded to about a 3 percent level, Stapley noted. Another plus is that core inflation has been very well contained and is now below 2 percent.  Too, the global economy has given “a huge, huge boost” to the situation the nation is facing today: For the first time in a decade, the global economy is growing faster than the U.S. economy. World GDP growth is expected to grow at about 5.2 percent this year, whereas the U.S. economy will probably grow at 2.5 percent or less. The value of the dollar on the foreign currency market is down 11 percent, and export spending around the world has been up 13 percent in the last year, Stapley noted.

 “The rest of the world’s demand for our exports is something that’s going to basically stabilize the downturn in our economy,” Stapley said.

“Michigan’s manufacturing community has really benefited from the decline in the dollar because the increase in exports has helped cushion, and in some ways eliminate, the impact of low GDP growth.”

For Michigan and all of the Midwest, the continuing struggles at Ford and GM will overshadow the economy for at least the next two years. Because the fundamentals are stronger today than in the past, the economic impact on the Midwest will be mitigated, though it will still lag behind the national economy. 

Stapley said volatility is to be expected in the financial markets, but what matters is that earnings growth still supports stock valuations. It’s not an expensive market, he stressed. He said international stocks represent near and long-term opportunities, and he reminded investors of the importance of diversification and re-balancing their portfolios for long-term performance. His current picks are stocks over bonds, large cap stocks over small cap, and higher quality over lower quality stocks and bonds.

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