OUTLOOK FOR 2010

This article is divided into three parts—(1) a factual description of the U. S. economy at present; (2) an analysis of the economy in 2010 and thereafter; and (3) the most likely outlook for the U. S. racing industry in the year ahead.

The U. S. economic situation as of January 1, 2010: The U. S. budget deficit for 2009 alone is larger than the Gross Domestic Product (GDP) of all nations of the world except for six and the U. S. is indebted to China alone for over $1 trillion. As of January of 2009, the U. S. debt was $10.6 trillion dollars and now it is $12.1 trillion, for an increase of $1.5 trillion or 14.2%. The U. S. Office of Management and Budget estimates that the national debt will increase to $17.5 trillion by 2019 and rise from 55.7% of GDP in 2009 to 76.5% in 2019. Currently, the U. S. has about $1.6 trillion of debt coming due, which is roughly double individual income tax revenues. (To compound the precarious global economic situation, China’s phenomenal growth is being funded with huge debt, leading Forbes magazine to refer to “Ponzi in Peking.”)

The Obama Administration and Congress are initiating even more costly social programs that will likely exacerbate the national debt more than is shown in the already startling and troubling estimates.

The unemployment rate is approximately 10%, the highest level in over a quarter century, and the unemployment rate plus the underemployment rate is much higher. In order to be classified as being unemployed, a person must reply yes to three questions:  “Are you without work? Are you available for work? Have you actively looked for work?” A part-time job would disqualify an individual from being categorized as unemployed, even though he/she may not have had a full-time job for years.

Bank lending to small business has decreased in the last four quarters.

According to research and analysis by Moody’s Economy.com, the residential real estate market is likely to see prices fall further in 2010–by 5% to 10% in most places and as much as 33% in Miami. About 23 percent of homeowners are “under water,” meaning that they owe more on their houses than the homes are worth. The commercial real estate market may be the next shoe to fall.

The U. S. government has taken an unprecedented financial interest in private companies and banks and interfered with privately negotiated agreements.

The tax cuts of 2001 are set to expire at the end of 2010. If these are not extended or made permanent, the tax increase will constitute the largest in history and be a huge drag on economic activity.

On the monetary front, the Federal Reserve is about out of bullets and the dollar is being devalued.

Analysis and Evaluation

The forgoing scenario is obviously grim and, if left unchanged, does not bode well for the U. S. economy in the decade beginning with 2010. However, the American economy is extremely resilient and usually bounces back nicely after a periodic recession that rids the economy of excesses, such as in the tech bubble of 2000 and the housing bubble that followed. This time the recovery may be slower because the problems in the financial system were so deep. Moreover, the economic medicine coming out of Washington is, on balance, doing more harm than good…especially for three-to-five years out. In spite of, or perhaps because of, a massive spending stimulus, the unemployment rate is stubbornly elevated.

As the experience of Japan in the 1990s demonstrates, massive government spending and near zero percent interest rates do not translate into a strong economy. What gets stimulated are pork projects and, in addition, when the stimulus money is no longer forthcoming, the jobs derived from such disappear. Mohamed El-Erian is the former head of the Harvard University endowment and is now the chief executive officer of PIMCO, which has over $1 trillion under management. He says the American economy is “on a sugar high. It feels good for a while but is unsustainable.”

All of this in combination is a recipe for a hard row to hoe in the longer term. In 2010, however, the recovery may be better than the economic facts indicate, simply because of the amount of money that the Federal Reserve has put into the system and because the economy is coming off such a low.

The powers that be in Washington would have been wiser to take measures with more immediate effect and to institute incentives to encourage entrepreneurial activity. For example, a temporary cut in the payroll tax would have shown up in workers’ paychecks immediately and would have avoided the inefficiency and delay of central planners in Washington doling out the largess. The U. S. corporate tax rate is one of the highest and needs to be cut. Capital gains taxes need to be kept low and the 2001 tax cuts need to be retained. Raising taxes could very well throw the economy back into recession. Finally, federal spending has to be curtailed in a major way.

One of the problems that the Obama administration and the majority party in Congress face is that their rhetoric contradicts what should be done. They have continually complained of “tax cuts for the wealthy” in a class warfare against investors and entrepreneurs. Factually, the most recent IRS data on who pays how much in federal income taxes is for 2007:

  • The top 1% of taxpayer returns had at least $410,096 in adjusted gross income and paid 40.42% of federal personal income taxes.
  • The top 5% had at least $160,041 in AGI and paid 60.63% of federal personal income taxes.
  • The top 10% had at least $113,018 in AGI and paid 71.22% of federal personal income taxes.
  • The top 25% had at least $66,532 in AGI and paid 86.59% of federal personal income taxes.
  • The top 50% had at least $32,879 in AGI and paid 97.11% of federal personal income taxes.
  • The bottom 50% had less than$32,879 in AGI and paid 2.89% of federal personal income taxes.

A large portion of the higher income tax categories is accounted for by small businesspeople, who tend to operate as S-Corps or LLC’s. Unlike C-Corps, the income earned in the business is treated as personal income to the small business owner and taxed at the relevant personal rate rather than at a corporate rate, as with a C-Corp. Tax incentives and disincentives for these people have an enormous effect on whether they will expand the scope of their operations and hire employees. With so much uncertainty and so many anti-business messages coming out of Washington, it is little wonder that small businesses have been battening down the hatches.

The best estimate here is that the U. S. economy will slowly recover in 2010. Here’s why I say slowly: The consumer, whose spending accounts for about 70% of GDP, is still generally scared for his/her job or is out of work. The individual’s house may be under water in that the mortgage exceeds the dwelling’s worth in the marketplace. This negative wealth effect provides neither the capability nor the inclination to spend. These factors, coupled with misguided government policies of out-of-control spending, almost assuredly higher tax rates to pay for it, and an increasing reliance on China to buy U. S. debt, portends trouble four or five years out. Even if there is a fast recovery in GDP and employment, it may be short-lived once the Congress and the Federal Reserve take away the punch bowl of colossal spending and easy money.

General Electric is a bellwether for the economy because of its diversification. Jeffrey Imelt, its chairman and CEO, predicted on December 15, 2009 that GE will have “flat” revenue and profits for 2010.

A bright spot for short-term recovery in 2010 is that Americans are paying down their debt. The Wall Street Journal reported on December 22, 2009, that “Household payments on mortgages and other debt, automobile leases, rent, homeowners’ insurance, and property taxes as a percentage of after-tax income fell to 17.8% in the third quarter. That is the lowest level since 2001. This should help households fix financial damage from the recession, but with net worth 19% below its peak, it will take time.”

2010 in the Racing Industry: A Forecast

The racing industry in the United States needs to be evaluated in two time frames in order to consider what 2010 is likely to bring—the first half of 2010 and the second half of 2010.

The initial five or six months of 2010 is likely to see the economy gradually recover but with unemployment remaining high compared to historical standards. This will affect the breeding industry and early-in-the-year auctions.

Mare owners will be cautious in deciding whether to book mares until economic conditions become clearer, even though drastically reduced stud fees will help temper the perceived risk. The fact that the breeding season in the Northern Hemisphere lasts from approximately mid-February through mid-June, weighs against a robust recovery. Because of the amount of fiscal and monetary stimulus in the American economy,  growth is likely to be  faster in the second half of 2010 than in the first half, or after the breeding season is over. By contrast, the other component of the racing industry, pari-mutuel handle, can turn upward in a hurry once economic conditions improve, particularly a drop in unemployment. Also look for the late summer auctions to show better results.

The economy is not likely to come roaring back, but it is beginning to recover. A promising if modest sign is that retail sales, excluding automobiles and gasoline, from November 1 through Christmas Eve 2009 showed a 3.6% increase over the same period a year earlier. (After adjusting for an extra shopping day in the 2009 period, the retail sales increase was approximately 1%.)

Anyone running an equine-related company can look to the future with hope, but hope is not a strategy. Incorporate into your plans a lukewarm-growth scenario (perhaps 2.5%- 3% GDP for 2010 and a year-end unemployment rate of 8%) with a high probability of occurrence. Anything better will be a pleasant surprise, and you will still be in business.

Copyright © 2010 Horse Racing Business

Comments

  1. Seems to me that if one is a breeder, it is necessary to look ahead two years. If one has a broodmare that has produced racing-quality foals with little trouble, the decision isn’t whether to cover her or not this year, the decision is with what. I would imagine that breeders would simply be choosing less-expensive sires rather than leaving mares empty. They still need to eat unless you’re going to cull the herd, so better to feed a producing mare than a barren one.

  2. It’ll be a wrenching decision, but I think major culling is in order. We need to get down to a foal crop of fewer than 25,000, taking into account the inevitable contraction in North American live racing that will occur over the next few years. That’s going to drive stud fees down, and put a lot of marginal stallions out of business. Unless — a probability on the order of pigs flying — the Jockey Club institutes curbs on the number of mares that can be bred to a signle stallion.

  3. Dan Cunningham says

    Federal income tax receipts are reportedly down 29 percent, meaning the economy has contracted far more than acknowledged. Unemployment is closer to 20 percent.
    If the foal crop decreases substantially, there will likely be an even higher concentration of foals from the very popular sires, further decreasing genetic diversity of a breed already prone to bleeding and unsoundness.

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