Economic Climate ~v~ This being the first TBR of 1986, it is appropriate to break from routine and devote some space to a new year's thoughtful prospective on the state's economy and where it is going. Anyone who has been keeping up with these outlook columns is aware that the Texas economy, as well as people's perceptions of the Texas economy, has undergone a significant reversal in the last year. How important is this reversal? Is Texas doomed, or, to borrow a phrase from Mark Twain, have reports on the death of the economy been greatly exaggerated? In trying to gain a global perspective of our situation, I found it instructive to review a theory of markets and expectation forma­tion described in John M. Keynes' landmark book, the General Theory of Employment, Interest, and Money. While it was written fifty years ago in the depths of the Great Depression, it still has relevance today. Keynes observed that bond price fluctua­tions brought about by changes in economic news are often quite out of proportion to the importance of the news. How else would one explain the tremendous drop in stock prices that followed the assassination of President Kennedy? The death of Kennedy was of no economic importance; yet the market suf­(~red a record-setting downturn. Keynes said, "Day-to-day fluctuations in the •) profits of existing investments which are of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd influence on the market. It is said, for example, that the shares of when their profits are seasonally high than in winter when no one wants ice.'' In Texas, the reaction of investors to re­cent changes in oil prices seems to be out of proportion to the real economic content of these changes. When oil prices rose in 1973 and again in 1979, exploratory and drilling activity increased enough to induce shortages of drilling pipe and other inputs to the in­dustry. The rental rate for offshore rigs skyrocketed, and the Hughes count of rotary rigs in operation rose from its pre-OPEC level of 1,100 to what will probably be its all-time high of 4,330 in 1981 (fourth quarter). The count roughly doubled after OPEC I and doubled again after OPEC II. In this heyday of exploration, equipment owners could charge excessive rents because investors dazzled by potential short-run pro­fits would pay just about anything to get their wells started. In our current heyday of gloom, this same equipment can be bought at scrap value. I believe at least part of this violent change is an overreaction to economic news, rather than a change in the long-range prospects for oil and gas. In 1977 and 1978, the price of oil was stable at just under $15 a barrel, and the rig count was stable at just over 2,000. Why should the count now be below 1,900 and still falling, when the price of oil is $28 a barrel? Part of the explanation lies in the fact that investment decisions cannot be based on the future income they will produce since future income is unknown at the time the invest­ment is being considered. Investment depends on expectation, or forecasts of future income. In the real world, income will till I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I ltnr take a few quarters or even years to adjust to changes in economic conditions, but forecasts of income can be doubled or cut in half as quickly as the computer can produce a new printout. Further, while we have a reasonable degree of confidence that historical data are accurate, we know from painful experience that forecasts have a wide margin of error. Even if a point forecast is quite optimistic, we will not invest if we feel that the forecast has a substantial downside risk. Thus, even if the computer does not spew forth a new set of forecasts, economic news that decreases people's confidence in forecast accuracy can induce a reduction in investment. When a piece of bad news casts uncertain­ty on the expected rate of return of a par­ticular investment, each investor hearing the news attempts to sell out before the rest of the investors find out. This attempt is futile because the very act of selling out sends market signals to other investors: the falling price of the investment tends to overshadow the original bad news. Similarly, good news can cause an upturn that is out of proportion to the real content of the news. The investor buys heavily in order to get in before everyone finds out about the new attrac­tiveness of the investment. One way to outwit this topsy-turvy world is to adopt a "contrary" strategy-to pick up undervalued investments while the crowd is sloughing them based on short-run con­siderations, hold them until the mob psychology swings to the opposite direction, and sell them at a profit. As "long as the in­dustry is fundamentally healthy and the in­vestor has the deep pockets needed to hang in during periods of negative cash flow, little risk is involved in adopting such a contrary strategy, and the long-term rewards can be substantial. Keynes felt that while some in­dividuals probably do follow a long-run strategy, they were so few that they could not have a significant influence on the market. Over the last year, our forecasts for Texas have not been glowingly optimistic. In the last few months, even the most enthusiastic boosters have been forced to face the fact that the glory days are over. The economic news is unambiguously bad for Texas. But, if you believe that mass psychology is usually wrong in the manner described above, then it should be clear that now is an excellent time to look into some contrary investing in Texas. The optimal long-run investment strategy in this environment is to identify the in­dustries that have growth potential on a na­tionwide basis and invest in those industries in Texas. Right now, the problems in petroleum and agriculture are diffusing through the entire Texas economy. We are seeing the exact reverse of the multiplier effect that helped us grow in the seventies and early eighties. The multiplier effect is that for every new dollar injected into a regional economy, the economy will grow by two or three dollars because the new dollar circulates, generating additional economic ac­tivity that is only loosely related to the original source of the dollar. This process works in reverse as well, and as a result, local industries that are only loosely related to agriculture and petroleum are sharing in the downturn of those sectors. Construction and real estate, both of which tend to feed off economic growth, are especially hard hit by the multiplier effect. However, for both of these industries, the long run looks good. The Texas population will continue to grow from the excess of births over deaths, even after net migration slows. This population will need structures in which to live and work, as well as roads and other facilities. Inasmuch as the Houston market is now a buyer's market and other major markets are swinging in that direction, there are many opportunities for an investor who is able to invest "for keeps" in Texas. -Jerry Olson Associate Director Leading Indicators The Bureau of Business Research index of leading economic indicators has remained relatively unchanged over the past three months. From September to November of 1985, the index remained stuck at about 0.91 (January 1982 = 1.0). Over this three-month period, manufacturing hours (the most im­ till I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I ltnr tftl I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IJDr Figure 1 Nonagricultural Employment in Five Largest Texas Metropolitan Areas (Index: January 1982 = 1.00) 1.35 __ ... ..... 1.30 --Austin 1.25 1.20 Dallas 1.15 ---------...,,,,,. -__,,,,--­ 1.10 Fort Worth-Arlington (line) __, 1.05 San Antonio (dash) .,,,,,,. •-~--:....:: - 1.00 Houston 0.90­ 0;95ll_____:::::::::=:::::::::::::::==;::=============J 1982 1983 1984 1985 Table 1 Nonagricultural Employment and Unemployment by Metropolitan Area Nonagricultural employment Unemployment (thousands) rate Area Nov. 1985 Nov. 1984 Percentage change Nov. 1985 ) Abilene 53.7 53.0 1.3 6.0 Amarillo 81.8 80.4 1.7 5.2 Austin 355.1 340.2 4.4 4.9 Beaumont-Port Arthur 136.1 143.0 -5.1 11.5 Brazoria 58.5 59.4 -1.5 7.4 Brownsville-Harlingen 64.8 64.1 1.1 12.8 Bryan-College Station 51.2 50.0 2.4 4.6 Corpus Christi 137.1 134.4 2.0 8.2 Dallas 1,254.9 1,238.2 1.3 4.6 El Paso 175.7 169.8 3.5 9.1 Fort Worth-Arlington 490.7 468.4 4.8 4.9 Galveston-Texas City 74.0 73.4 0.8 9.8 Houston 1,500.9 1,472.6 1.9 6.9 Killeen-Temple 67.0 65.1 2.9 8.2 Laredo 33.1 32.0 3.4 12.7 Longview-Marshall 65.7 67.1 -2.1 9.4 Lubbock 95 .6 93.4 2.4 4.9 McAllen -Edinburg-Mission 83.1 80.1 3.7 17.1 Midland 52.3 53.0 -1.3 4.3 Odessa 53.6 53.8 -0.4 5.1 San Angelo 39.1 38.8 0.8 4.1 San Antonio 477.3 466.6 2.3 5.6 Sherman -Denison 37.6 37.2 1.1 6.3 Texarkana 46.3 45.9 0.9 8.8 Tyler 65.7 61.0 7.7 6.5 Victoria 29.3 29.5 -0.7 6.9 Waco 78.3 78.0 0.4 5.2 Wichita Falls 51.7 51.5 0.4 5.5 Total Texas 5,710.2 5,599.9 2.0 6.5 Note: These data reflect the Bureau of Labor Statistics ' redefined metropolitan areas in Texas. Source: Texas Employment Commission. tftl I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IJDr tdll I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IJDr Figure 3 Texas Index of Leading Economic Indicators (January 1982 = 1.00) 1.02 1.00 0.98 0.96 0.94 0.92 0.90 0.88 0.86 ---------------­ 1982 1983 1984 1985 portant component in the index) and initial claims for unemployment insurance remained relatively unchanged, while retail sales and new housing permits fell and oil prices strengthened. As noted in the December Texas Business Review, most of the improvement in the leading indicators index from July to September of 1985 was the result of increases in retail sales and new housing permits. As was anticipated, however, retail sales and new housing permits have again begun fall­ing off because of the general weakness of the state's economy. The increase in oil prices from September to November of last year may come as a bit of a surprise given the near panic that hit world oil markets in mid-December. Al­though it may now seem to be a distant memory, oil prices strengthened in the fall of 1985 because of tight inventories of crude at refineries and the need to increase heating oil production for the winter. At one point, the spot price of West Texas intermediate rose to almost $32 per barrel before falling as far as $25 per barrel in the middle of December. Currently (early January), the spot price of West Texas intermediate is at about $26 per barrel-the same level as one year ago. Table 2 Components of the Texas Index of Leading Economic Indicators (September-November 1985) Measure Sept. Oct. Nov. Manufacturing weekly hours 41.20 41.40 41.40 Retail sales (billions of 1967 dollars) 2.63 2.51 2.52 New housing permits (thousands) 10.69 9.96 9.72 U.S. wellhead price of oil (1967 dollars per barrel) 7.54 7.59 7.57 Initial claims for unem­ ployment insurance (claims per thousand employees) 10.16 10.53 10.05 Leading indicators index (January 1982=1) 0.91 0.90 0.91 Note: All figures are seasonally adjusted. Sources: Texas Employment Commission, U.S. Bureau of the Census, and U.S. Department of Energy. Overall, the leading indicators index sug­gests a continuation of sluggish growth in the Texas economy. The decline in state goods employment appears to have ended for now, but another fall-off is possible this spring if oil prices fall significantly. On the other hand, state service-producing employment has shown surprising strength in recent months because of strong growth in finance, insurance, and real estate and government employment. State nonfarm employment growth actual­ly increased from a 1.2 percent annual rate in the third quarter of 1985 to an estimated 3.5 percent rate in the fourth quarter (based on November data). The increase in state employment growth at the end of 1985, however, should be viewed as an anomaly. Even though the employment data are seasonally adjusted, the same upsurge of growth in the fourth quarter has been observed in the past three years, only to be followed by a significant growth slowdown. -Thomas R. Plaut Manager, Economic Forecasting tdll I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I IJDr JAllllllll lllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllAr Economic Outlook for Beaumont, Port Arthur, and Orange The Beaumont -Port Arthur -Orange area is the most heavily industrialized region in Texas. Nearly 38 percent of the region's economic output is produced by manufactur­ing. Oil refining and petrochemicals are, by far, the most important manufacturing industries. The impact of the early 1980s national recession on the region is still being felt. Declining world oil prices, the construction of refining and petrochemical complexes in the Mideast, Canada, and Mexico, and the massive downturn in domestic oil and gas drilling have introduced a great deal of uncertainty. All of these events are beyond the control of the region and the state of Texas. It appears that the worst is over and a slow but sure recovery in the region is begin­ning. Employment in manufacturing is stabi­lizing after a downturn while employment in construction and finance, insurance, and real estate is steady, and the wholesale trade, retail trade, and services employment growth is now positive. In the next few years, the region's employ­ment growth may be expected to follow the Projections of Population for the United States, Texas, and the Beaumont-Port Arthur-Orange Area Population (millions) Area 1984 1989 1994 United States 236.4 247.5 257.7 Texas 16.1 17.8 19.2 Beaumont-Port Arthur-Orange 0.391 0.421 0.454 growth patterns of the state. Wholesale and retail trade employment should grow at an annual rate of 2 percent; the service sector at 2.7 percent; finance, insurance, and real estate, 3.4 percent; construction, 3.5 percent; and state and local government, 3 .1 percent. Chemical and allied products manufacturing employment will probably average 1.5 per­cent growth per year after continued stabilization for the next few months . .# Employment in petroleum refining will prob­ably hover around a zero growth rate as in­ternational competition intensifies. Community leadership, which continues to play a major role in the economic develop­ment process, is a nonquantifiable element in the region's economic outlook. Leaders in this region recognize the need to diversify the economy. As a matter of fact, they have been working diligently to do so. These ef­forts are now beginning to show positive results. -Victor L. Arnold Director, Bureau of Business Research Jtlllllllll lllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllllAr NONPROFIT ORG. U.S. Postage PAID Austin, Texas Permit No. 1630 TX UNIV OF /TBRND86 GENERAL LIBRARIES 2 PCL 1 11~ SERIALS RECORDS CAMPUS MAIL Texas Business Review is published six times a year (February, April, June, August, October, and December) by the Bureau of Business Research, Graduate School of Business, University of Texas at Austin. Texas Business Review is distributed free upon request. * * * The Bureau of Business Research serves as a primary source for data and information on Texas and on the dynamics of change. The Bureau's research program concentrates on the determinants of regional growth and development and investigates specific issues for clients. The information services division answers inquiries by telephone and mail, responds to walk-in visitors, and offers com­puterized data from the 1980 census of the population and on manufacturing firms in Texas. The publications division produces periodicals, directories, books, and mono­graphs on a variety of topics that shape the development of the Texas economy. -tttl I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I l'Ar . Announcements Bureau Director Victor L. Arnold has taken a twenty-month leave of absence to serve as executive director of the Select Com­ mittee on Higher Education in Texas. During his absence Robert D. Mettlen, U.T. Vice­ President for Planning and Special Projects, will serve as acting director of the Bureau. Dr. Mettlen, who joined the U. T. Finance Department in 1966, is also Lamar Savings Centennial Professor of Finance. To request that your name be added to the mailing list for Texas Business Review, • please call 512/ 4 71-5179 (Sales Office).