Economic Report December 2016 Prepared for Commerce National Bank & Trust By Jett Lazarus Disclaimer: All information in this report is for general information and educational purposes only, and should not be taken as financial advice.  

The 2008 Great Recession On December 1st of 2008, the National Bureau of Economic Research announced that we had been in recession since December of 2007. By the time our government declared recession, it was too late. Home prices had already fallen 37% and our economy was in shambles. We can’t rely on the government to tell us when the economy is shifting gears. However, we have four leading indicators that may be useful in predicting the next recession.

The Recovery Since the financial crisis: Real estate has recovered Historically low interest rates Steady increase in employment Reasonable home affordability Low inventory A surge in cross-borders investment in U.S. real estate Rising home prices The stock market at an all-time high Rise in corporate profits since 2009 Consumer Optimism highest level since 2001 Extreme optimism on Trump’s election Market rally of 10% since November Confidence that Trump will create and keep jobs and remove business regulations, which may spur growth

Overview Section 1 – Leading Indicators Section 2 – Economic Update Section 3 – Appendix

Leading Indicators Section 1 The strength of the economy is determined by several factors such as GDP growth, wages, the unemployment rate, business and consumer spending, interest rates, and government policy, just to name a few. There are hundreds of economic indicators which make it difficult to determine which ones to follow. Yet much of this data is noise; it fails to provide an accurate forecast of the next downturn. Here are 4 leading indicators that I find useful in forecasting the future direction and condition of the economy and real estate: 10 / 2 Year Treasury Yield Spread (Warning indicator, 2 – 3 years) The Unemployment Rate (Confirmation indicator) Months Supply of Housing Inventory (for Orlando real estate) Housing Affordability Index (for Orlando real estate)

1) 10-2 Year Treasury Yield Spread 10 year treasury rate – 2 year treasury rate A measure of “monetary tightness” What determines these rates? 10 year rate determined by the bond market 2 year rate set by the Federal Reserve When the 2 year treasury yield exceeds that of the 10 year, the spread has become ‘inverted’. An inversion of the yield spread results from: The bond market forecasting a future downturn in the economy The Fed raising short-term interest rates to control market conditions (tightens money supply to fight inflation)

10-2 Year Treasury Yield Spread (Pt. 2) 0.25 % 0 % Difference in % Yield U.S. recessions indicated in red. l l l l 7 Year If spread falls below 0.25% (horizontal red line), a recession is expected in 2-3 years. An inverted yield spread has preceded the past four recessions. 1.33% (12/22/2016)

2) Unemployment An increase in unemployment often occurs in a recession, as seen in both the 2008 Great Recession and The Great Depression of the 1930’s. The U-3 unemployment is used in this report, which does not include discouraged and part time workers. This figure is used because there is more historical data. UPDATE: As of November 2016, the unemployment figure is still falling, which indicates that the economy is still in its expansion phase.

Unemployment – Early 2000s Recession (Pt. 2) Historically, a rise in unemployment (3 months in a row, year over year) has indicated the start of a recession. Red = recession Green = Recovery July 17, 2003 November 26, 2001 National Unemployment Rate National Unemployment Rate The Great Recession Rising unemployment indicated a recession on April of 2001. Falling unemployment indicated a recovery on February of 2004.

Unemployment – The Great Recession (Pt. 3) Historically, a rise in unemployment (3 months in a row, year over year) has indicated the start of a recession. Red = recession Green = recovery December 2008. September 20 2010 National Unemployment Rate National Unemployment Rate The Great Recession Rising unemployment indicated a recession on December of 2007. Falling unemployment indicated a recovery on September of 2010.

3) Real Estate Inventory This measure is calculated by dividing the existing number of homes for sale by the average number of sales per month. The average figure for Orlando is 6 months of inventory. At this level, the market is considered at equilibrium, and it would take 6 months to deplete the market’s supply of real estate if no new homes were listed. UPDATE: As of November 2016, the Orlando market has 3.74 months of inventory, which is low. This data suggests that real estate is not overbought, and will likely appreciate until inventory exceeds 7 months supply.

Real Estate Inventory (Pt. 2) 7 months or more of inventory indicates an oversupply of real estate, which could lead to future price decreases in Orlando/Winter Park. 6 months is considered balanced for this market. http://tinyurl.com/h5ncf6p Excess inventory signaled real estate devaluation on October, 2006.

Orlando Realtor Association – Monthly Sales & Inventory Reports 3) Real Estate Inventory (Pt. 3) When inventory falls below 5 months of inventory, real estate is in short supply. Prices are expected to rise. Orlando Realtor Association – Monthly Sales & Inventory Reports Current Data: http://tinyurl.com/h5ncf6p Low inventory signaled a recovery in real estate on June, 2011.

3) Real Estate Inventory (Pt. 3) 3.78 months of inventory as of November, 2016 indicates a stable real estate market in Orlando. R = -.834 Orlando Median Home Prices (October of each year) Provided by Orlando Realtor Association Median Home Price Orlando Housing Inventory Provided by Orlando Realtor Association Months Supply of Inventory

4) Housing Affordability Index The HAI measures whether the typical family could qualify for a mortgage on a typical home. Formula HAI = Median Family Income / Qualifying Income * 100

4) Housing Affordability Index (HAI) Orlando A value of 110% or less indicates residential real estate is overvalued. http://tinyurl.com/hqcbx8t Updated Monthly

Summary of Leading Indicators 12/5/16 2-3 Years Leading 1-2 Years Leading 10Yr/2Yr Treasury Yield Current 1.33% Alert 0.25% http://tinyurl.com/h9e4ljh Housing Affordability Nov, 2016 160.37% Alert Below 110% http://tinyurl.com/jfayp5s Housing Inventory 3.73 months above 7 months Confirmation U-3 Unemployment Sep-16 5.0% 15-Sep 5.1% Oct-16 4.9% 15-Oct Nov-16 4.6% 15-Nov Alert 3 consecutive, month-over month increases from previous year Last Update 12/2/2016 http://tinyurl.com/3gss8qd No real estate collapse anticipated in the next 2 years. No recession anticipated in the next 2 years. 17

2016 Report U.S. Federal Debt Student Loan Debt vs. Starting Salaries Section 2 U.S. Federal Debt Student Loan Debt vs. Starting Salaries Health Care Costs Home Ownership Rate Statistics, 2007 vs. 2008 vs. 2016

U.S. Federal Debt https://fred.stlouisfed.org/series/GFDEGDQ188S Updated Quarterly Largest Contributors: Healthcare Programs - $940B Social Security - $882B National Defense - $718B

Student Loan Debt & Starting Salaries Average Debt Per Borrower In Each Year’s Graduating Class 7 in 10 seniors graduate with debt In 2000, debt averaged $17,268.80 In 2016, debt averaged $37,172 .00 About $1.2 trillion in student loan debt Majority owned by federal government (80%+) 11.3% of student borrowers default on these loans. A 53% increase after inflation adjustment http://tinyurl.com/jk2ojct Updated Quarterly

Student Loan Debt (Pt. 2) http://tinyurl.com/gqorp8d As college costs rise, starting salaries remain stagnant. As of April, 2016 : over 40% of students are not making payments They are behind on $200 billion owed. 2016 http://tinyurl.com/gqorp8d http://tinyurl.com/jr7h3rp WSJ

Health Care Costs http://tinyurl.com/kl38vt4 Aging US Population Huffington Post http://tinyurl.com/hrw2hv9 WSJ Aging US Population Obamacare Rising obesity Physician shortage Slow approval of generic medicine

Home Ownership Rate since 1960s Number of U.S. Households vs. Age of Homeowner *Includes homeowners of all ages Falling affordability Rising house prices Stagnant wages Tighter Lending Qualifications Increasing student loan debt http://tinyurl.com/jkumfho Updated Monthly

Statistics: 2007 & 2008 vs. November, 2016  National 9/2007 9/2008 11/ 2016 Employment to Population Ratio 62.9 61.9 59.7 Unemployment Rate 4.70% 6.1% 4.6% Real Median Income $57,423 $55,376 $57,616 Poverty 12.50% 13.20% 12.40% Debt to GDP Ratio 61.83% 73.54% 104% Home Ownership, Southern U.S. 68.2% 67.9% 63.5% Orlando Real Estate 11/2016 Interest Rate (30-Year Fixed) 6.38% 6.04% 4.13% Median Home Value $235,000 $181,995 $205,000 Median Home Value Change from Previous Year -6% -23% +13.95% Months Supply of Inventory (LT Avg: 6) 27.2 17.7 3.74 Change in Default Rate of First Mortgages from Previous Year +72% +83% -21.2% Orlando Home Affordability Index 92.4% 123.74% 160.37%

Appendix Section 3 Key Leading Indicators (Pages 26 – 27) Unemployment (Pages 28– 29) Real Estate Inventory Other Useful Data (Pages 30 –31) Real Estate Prices (Page 32) Delinquency Rate of Residential Mortgages (Page 33) Household Debt Payments (Page 34) 90 Day Auto Loan Delinquency (Page 35) Effective Fed Funds Rate (Page 36) Possible Causes of Next U.S. Recession

Historical Unemployment Rate, 1980 to 2016 (BLS.gov) (Shaded indicates recession) http://tinyurl.com/3gss8qd Updated Monthly by BLS

Historical Unemployment Rate, 2000 to 2016 6 = LT average http://tinyurl.com/6l5eaw2 Updated Monthly by Trading Economics

US Monthly Inventory since 1960’s (Shaded indicates recession) http://tinyurl.com/z34kmcc Updated Monthly

U.S. Real Estate Housing Inventory Hyper supply http://tinyurl.com/z34kmcc Updated Monthly

Real Estate Prices In Orlando, Real Estate prices have rebound sharply since 2011. Recently, the median price of single family homes in Winter Park has reached its 2007 nominal peak. However, if adjusted for inflation, Winter Park housing prices are still 12% below the previous market high. Low interest rates, housing inventory, and mortgage default rate highlight this very healthy market.

Prices vs. Rents, 1994 to Q4 2015 http://tinyurl.com/cfoya2w This index compares global house prices against rents. ‘100’ represents the long term average. http://tinyurl.com/cfoya2w Updated N/A

Delinquency Rate of Residential Mortgages Compares the prices of the same single family homes over time. Base index value = 100. (Shaded indicates recession) Delinquency rate on single-family residential mortgages. http://tinyurl.com/zov3nkc Updated Quarterly

Household Debt Service Payments as a Percent of Disposable Personal Income Updated Quarterly This index tracks a ratio of household debt payments to total disposable income. http://tinyurl.com/jmkgo8u Updated quarterly

90 Days Auto Loan Delinquency http://tinyurl.com/zvm484g Updated Monthly This index tracks late auto payments.

Effective Federal Funds Rate, Since 1955 http://tinyurl.com/j5p682z Updated Monthly

The Next U.S. Recession Possible Causes: Personal Debt Crisis Inflated mortgage payments due to higher home prices & interest rates Rising student debt Lack of wage increases Backfire of Fed Monetary Policy The economy has expanded due to artificially low rates The stock market has reached an all-time high Since December 2015, rates are on the rise A Second Housing Crisis Real estate appreciation may continue to outpace wage growth Rising mortgage rates Further speculation of prices & selloff of investment property