Women, Work and the Pandemic: a Search for Balance

THE REAL

VOLUME 79 ECONOMY

WOMEN, WORK AND THE PANDEMIC: A SEARCH FOR BALANCE

HOW GOVERNMENT PAYMENTS HELPED RESTORE HOUSEHOLD BALANCE SHEETS WHAT’S BEHIND THE DECLINE IN 10-YEAR TREASURY YIELDS? THE ALTERNATIVE: RISING RENTAL MARKET IS TIED TO LIMITED SUPPLY, NOT AFFORDABILITY INDUSTRY SPOTLIGHT: SPAC IPO MARKET PAUSES AS INVESTORS AND REGULATORS REEVALUATE MIDDLE MARKET TREND WATCH: IN MMBI SURVEY, A CALL TO SHORE UP THE NATION'S INFRASTRUCTURE ABOUT THE AUTHORS

Our thought leaders are professionals who strive to help you and your business succeed. Contributors to this issue include:

JOSEPH BRUSUELAS KENNEDY CHINYAMUTANGIRA CHIEF ECONOMIST, RSM US LLP SENIOR MANAGER FINANCIAL SERVICES SENIOR ANALYST

LAURA DIETZEL TROY MERKEL PARTNER PARTNER REAL ESTATE SENIOR ANALYST REAL ESTATE SENIOR ANALYST

ANNE SLATTERY DIRECTOR INDUSTRIALS SENIOR ANALYST

This publication represents the views of the author(s), and does not necessarily represent the views of RSM. This publication does not constitute professional advice.

2 | JULY 2021 WOMEN, WORK AND THE PANDEMIC: A SEARCH FOR BALANCE BY JOSEPH BRUSUELAS, LAURA DIETZEL AND ANNE SLATTERY

DURING THE PANDEMIC, women have taken the brunt Real earnings by gender, 1980-2020 and loss of of the damage to the labor force, whether it’s losing their earnings during the pandemic jobs or working triple time at home with child care and MEDIAN WEEKLY EARNINGS IN CPIADJUSTED, 198284 CONSTANTDOLLAR TERMS FOR WAGE AND SALARY WORKERS 16 AND OLDER education duties on top of their work obligations.

450 Real wage differentials between men and women All men: 3.8% loss during the pandemic have turned into a chasm, with the 400 gap increasing by more than 19% at the depths of the 350 economic disruption. The labor force participation rate of All women: 4.9% loss 300 women 20 and older has declined to 57.4% from the pre- pandemic rate of 59.2%. 250

Earnings per week (1982–84 $) per week Earnings 200 Overall, 1.8 million fewer women were working in the 1980 1985 1990 1995 2000 2005 2010 2015 2020 labor force in May than in February 2020. In fact, one All men 16+ All women 16+ of the major barriers to reentry to the workforce Source: BLS; FRED; RSM US LLP for women is the confluence of schools not being completely reopened and limited child care options. This condition is not sustainable.

RSM | THE REAL ECONOMY | 3 REAL WAGE DIFFERENTIALS BETWEEN MEN AND WOMEN DURING THE PANDEMIC HAVE TURNED INTO A CHASM, WITH THE GAP INCREASING BY MORE THAN 19% AT THE DEPTHS OF THE ECONOMIC DISRUPTION.

Closing the earnings gap between male and female MIDDLE MARKET INSIGHT wage workers MEDIAN WEEKLY EARNINGS RATIO IN CPIADJUSTED, 198284 CONSTANTDOLLAR As the hospitality sector opens up, we could TERMS FOR WAGE AND SALARY WORKERS 16 AND OLDER expect women to rejoin the labor force at 1.70 In 1980, men were earning nearly 1.6 increased rates. times the earnings of women 1.60

1.50 In 2020, men were earning about 1.2 times the earnings of women The following is the first in a series of analyses on women 1.40 in, and out of, the labor force. While there has been 1.30 1.20 progress toward gender (and racial) equality, the peculiar 1.10 nature of the pandemic resulted in some backtracking. Earnings ratio per week (1982–84) per week ratio Earnings 1.00 A variety of labor market indicators point to the need 1980 1985 1990 1995 2000 2005 2010 2015 2020 Men-to-women earnings ratio for systemic change in the labor force. One of the more pressing policy challenges in the post-pandemic economy Source: BLS; FRED; RSM US LLP will be to reverse those setbacks.

Earnings of wage and salary workers There are a host of reasons for the larger drop in women’s wages during the 2020 economic shutdown, including It’s no secret that women earn less than men. According the retention of men with higher seniority than women, to the median weekly earnings of wage and salary the resurgence of manufacturing, and the dormancy of workers in real (constant dollar) terms, this is the service-sector industries. unfortunate reality of the U.S. labor market. But there are reasons not to give up on the push for Over a half century ago, one might have heard arguments gender equality. Though the ratio of men’s-to-women’s that a preponderance of men working in higher-paid wages seems to have hit a roadblock after improving production industries and women working in lower-paid from 1980 to 2005, this setback might be attributable occupations like secretaries, teachers or hospitality more to family obligations that tend to fall more on workers was the reason. But that is not the case today. women than men.

Yes, there have been advances in closing the earnings gap If there are lingering occupational preferences on the part in occupations that pay wages and salaries. In 1980, real of both employees and employers, that should become wages and salaries (earnings in inflation-adjusted terms) a thing of the past as the workplace adapts to the for men were nearly 1.6 times that of women. requirements of the new economy. But as manufacturing jobs began to disappear and the Labor force participation rate service sector became dominant, that ratio dropped toward a new equilibrium centered on wages for men that Several trends were affecting the labor force participation are 1.2 times that for women. rate among men and women before the pandemic.

Then the pandemic hit. In the last quarter of 2020, Although 90% of men—those 20 and older—were active real wages and salaries of men had dropped by 3.8% workers or were actively seeking employment in 1950, compared to the last quarter of 2019. The real wages of that figure had dropped to 75% by the onset of the women dropped by 4.9%. Great Recession. Women’s role in the labor force was a mirror image, increasing from a participation rate of 31% in 1950 to a peak of 61% in 2008 as both employment opportunities and family roles were changing.

4 | JULY 2021 IN THE LAST QUARTER OF 2020, REAL WAGES AND SALARIES OF MEN HAD DROPPED BY 3.8% COMPARED TO THE LAST QUARTER OF 2019. THE REAL WAGES OF WOMEN DROPPED BY 4.9%.

The Great Recession arguably prompted another shift. Combining those discouraged workers with those who By 2010, baby boomers began to leave the labor force. By are actively looking for a job, we can calculate a “non- 2019, the participation rate for men had declined to 71%, employed rate.” As our analysis shows, the non-employed while only 59% of women remained in the labor force. rates for men and women in their prime working years of 25 to 54 jumped during the pandemic, with twice as many By April 2020, the pandemic had reduced the number women as men estimated to be not looking for work. of men 20 and older in the labor force by 3 million (or 3.6%) relative to 12 months earlier, and a labor force Non-employed rate for prime-working-age men participation rate of 65.6%. There were 2.6 million (or and women 3.5%) fewer women in the labor force, for a participation PEOPLE 2554 UNEMPLOYED AND NOT LOOKING FOR WORK rate of 56.3%. 80% 2020–21 Pandemic From September 2020 to February 2021, women were 70% recession 60% leaving the labor force at a faster rate than men. Reports May 2021 50% Women suggested that more women were staying home to Women entering 29% non-employed rate 40% the labor force Men care for their children, which might have a lot to do 17% non-employed rate 30% with existing wage and salary disparities, as well as the 20% 1950–70 postwar industrialization reassertion of traditional family roles in the absence of 10% Percent of prime-age men and women of prime-age Percent affordable child care services. 0% 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021 As the hospitality sector opens up, we could expect Recession indicator Male non-employed rate (%) Female non-employed rate (%) women to rejoin the labor force at increased rates. Source: BLS; NBER; RSM US LLP Long-term trends in the labor force participation rate by gender At the end of 2019, 6.5 million men in their prime working MALES AND FEMALES WHO ARE 20 AND OLDER years were estimated to be not looking for work. By May this year, we estimate that 7.2 million prime-age men 100 2010–21 had opted out of the labor force, an increase of more than 90 Decline in baby boomer participation during economic recovery 690,000 and making for a non-employed rate of 17%. 80 70 1950–2000 At the end of 2019, 14.3 million prime-working age women 60 Women entering the labor force were estimated to be not looking for work. By this May, 50 we estimate that 15.2 million prime-age women had opted 40 30 out of the labor force, an increase of more than 850,000

% of people 20 and older in the labor force 20 and making for a non-employed rate of 29%. 1951 1961 1971 1981 1991 2001 2011 2021 Recession indicator Males Females We can attribute the gap in the non-employed rate

Source: BLS; Bloomberg; RSM US LLP between men and women to the lack of child care alternatives for women and to the lag in service-sector The non-employed rate employment compared to employment in the production industries. The headline unemployment rate counts only those • workers who are actively looking for employment, which is an accepted measure of tightness in the labor market during normal periods of the business cycle. Nonetheless, there are people who become disenchanted with wage levels or discouraged by the lack of local employment opportunities and stop looking for work.

RSM | THE REAL ECONOMY | 5 HOW GOVERNMENT PAYMENTS HELPED RESTORE HOUSEHOLD BALANCE SHEETS BY JOSEPH BRUSUELAS

CONSUMERS CONTINUED their pandemic-era In one sense, those government transfers to households rebalancing of household finances in the first quarter, have in a modest way helped millions of Americans shedding credit card debt and home equity lines of credit. rehabilitate their balance sheets. Over a decade ago, the These adjustments to household balance sheets appear government took a not too dissimilar approach, but with consistent with increases in government transfers and major banks, when it sponsored a de facto bailout of changes in buying habits during the pandemic. those large and systemically important institutions.

This underscores the powerful release of pent-up demand But not all of those fiscal transfers have gone into that will be the foundation of this year’s economic boom spending. Instead, a significant portion is being retained and will provide the overarching narrative for the first as outright savings or through the paying down of debt. phase of the recovery and expansion. Our estimation is that households will largely save 30% of those government transfers, use 30% to pare down debt Government efforts to maintain income streams and and spend 40% of them over this year and next. spending during the pandemic have been successful, as evidenced by the recoveries in retail sales and in We categorize paying down debt as a form of personal consumption expenditures since the depths of precautionary savings, in which households give the pandemic. themselves more room to maneuver should expenses once more overwhelm available income during the inevitable economic shakeout of the post- pandemic recovery.

6 | JULY 2021 THE LARGEST INCREASE IN THE COMPOSITION OF DEBT HAS BEEN IN STUDENT LOANS, WHICH GREW FROM 5% OF TOTAL CREDIT IN 2008 TO THEIR 11% SHARE IN 2021.

This reduction of debt should also reinforce the First quarter consumer credit in five charts improvements in household balance sheets and the overall economy as Americans gain confidence in their Total consumer credit grew by 0.6% in the first quarter own financial conditions. compared to end-of-year 2020. On an annualized basis, that would be a growth rate of 2.4% in 2021 were Credit card debt was reduced by $157 billion in the five first-quarter growth to continue for the rest of the quarters of the pandemic (from the end of 2019 through year. By comparison, total consumer credit had been the first quarter of 2021), including a $49 billion drop in the growing at an average 3.5% yearly rate in the five years first quarter. Credit card debt was growing at a five-year before the pandemic. average rate of 5.4% per year before the pandemic, but grew by only 2.6% on a year-over-year basis in the first U.S. consumer debt outstanding–levels and growth quarter of 2021. TRILLIONS OF DOLLARS AND YEAROVERYEAR % GROWTH RATE

16 20% Home equity lines of credit were reduced by $55 billion 2007–09 2020-21 14 Financial crisis rebalancing of Pandemic shock and during the five quarters of the pandemic, including a drop household ﬁnances paydown of debt 15% 12 of $14 billion in the first quarter of 2021. Home equity 10% financing has been in general decline since the early 10 2000s, with negative growth since 2012. 8 5% 6

Level (US$ tn) Level 0% 4 Growth rate (YOY %) (YOY rate Growth According to an analysis by the Federal Reserve Bank of -5% New York, in total, “non-housing balances declined by $18 2 0 -10% billion, with increases in auto and student loans offset by 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 the declining credit card balance.” Consumer credit outstanding (US$ tn) (YOY %) (RHS)

Source: Federal Reserve; Bloomberg; RSM US LLP

Levels and changes in consumer credit outstanding during the first quarter of 2021 CHANGES RELATIVE TO BEFORE THE PANDEMIC AND SINCE THE END OF 2020

US$ trillions Total consumer Mortgage Home equity Auto Credit card Student Other Credit outstanding: credit debt lines of credit loans debt loans debt as of Dec. 2019 14.15 9.56 0.39 1.33 0.93 1.51 0.43 as of Dec. 2020 14.56 10.04 0.35 1.37 0.82 1.56 0.42 as of March 2021 14.64 10.16 0.34 1.38 0.77 1.58 0.41 US$ billions Change since Dec. 2019 499 603 -55 51 -157 76 -19 Change since Dec. 2020 85 117 -14 8 -49 29 -6 Percent change Change since Dec. 2019 3.5% 6.3% -14.1% 3.8% -16.9% 5.0% -4.4% Change since Dec. 2020 0.6% 1.2% -4.0% 0.6% -6.0% 1.9% -1.4%

Source: Federal Reserve; Bloomberg; RSM US LLP

RSM | THE REAL ECONOMY | 7 Mortgage debt grew by 1.2% in the first quarter compared Credit card debt declined by 6% in the first quarter to end-of-year 2020. On an annualized basis, that would compared to end-of-year 2020. On an annualized be a growth rate of 4.7% in 2021, compared to its five-year basis, that would be a drop of nearly 22% in 2021, pre-pandemic average 3% yearly rate. compared to its five-year pre-pandemic average 5.4% yearly growth rate. At least some of those increases in mortgages outstanding can be attributed to shifts in housing This growing reluctance of households to accumulate preferences and the hot housing market during debt, should it continue beyond the vaccination program, the pandemic. might not become a drag on the economy if households reduce their precautionary savings, wage increases U.S. mortgage debt outstanding–levels and growth sustain their pandemic gains, and infrastructure programs TRILLIONS OF DOLLARS AND YEAROVERYEAR % GROWTH RATE accomplish their goals.

12 25% 2007–09 2020-21 U.S. credit card debt outstanding–levels and growth Financial crisis rebalancing Pandemic shock 10 of household ﬁnances 20% TRILLIONS OF DOLLARS AND YEAROVERYEAR % GROWTH RATE 15% 8 1.0 15% 10% 2007–09 2020–21 Financial crisis rebalancing of Pandemic shock 6 0.9 household ﬁnances and paydown of debt 10% 5% 0.8

Level (US$ tn) Level 4 0.7 0% 5%

Growth rate (YOY %) (YOY rate Growth 0.6 2 -5% 0.5 0% 0 -10% 0.4

Level (US$ tn) Level -5% 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 0.3

Mortgage debt (US$ tn) (YOY %) (RHS) 0.2 %) (YOY rate Growth -10% 0.1 Source: Federal Reserve; Bloomberg; RSM US LLP 0.0 -15% 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Credit card debt (US$ tn) (YOY %) (RHS) Auto loans grew by 0.6% in the first quarter compared to end-of-year 2020. On an annualized basis, that would Source: Federal Reserve; Bloomberg; RSM US LLP be a growth rate of 2.3% in 2021, compared to its pre- pandemic five-year average 7.4% yearly rate. Student loans outstanding grew by 1.9% in the first quarter compared to end-of-year 2020. On an annualized This runs counter to the narrative regarding the drop in basis, that would imply an increase of 7.7% in 2021, inventory. But a consumer shift to less expensive used compared to its pre-pandemic five-year average 5.8% cars and to general household cost-cutting most likely yearly growth rate. accounts for the long-term slowing growth of auto loans. Increased student loan debt should not be confused U.S. auto loans outstanding–levels and growth with the rising cost of higher education, which is TRILLIONS OF DOLLARS AND YEAROVERYEAR % GROWTH RATE partly a reflection of families’ willingness to pay. Still, a persistent increase in education costs is likely to have a 1.6 25% 2007–09 2020-21 sustained effect on household expenses and an impact 1.4 Financial crisis rebalancing Pandemic shock 20% of household finances on overall inflation. 1.2 15% 1.0 10% U.S. student loans outstanding–levels and growth 0.8 5% TRILLIONS OF DOLLARS AND YEAROVERYEAR % GROWTH RATE 0.6 0% Level (US$ tn) Level 0.4 -5% Growth rate (YOY %) (YOY rate Growth 1.8 25% 2007-09 2020–21 0.2 -10% financial crisis rebalancing Pandemic shock 1.6 of household finances and paydown of debt 0.0 -15% 1.4 20% 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 1.2 Auto loans (US$ tn) (YOY %) (RHS) 15% 1.0 0.8 Source: Federal Reserve; Bloomberg; RSM US LLP 10% Level (US$ tn) Level 0.6 Growth rate (YOY %) (YOY rate Growth 0.4 5% 0.2 0.0 0% 2006 2008 2010 2012 2014 2016 2018 2020 Student loans (US$ tn) (YOY %) (RHS)

Source: Federal Reserve; Bloomberg; RSM US LLP

8 | JULY 2021 WHETHER THIS ERA OF BELT-TIGHTENING CONTINUES MIGHT DEPEND ON THE ABILITY OF THE GOVERNMENT TO INVEST IN A RE-IMAGINED ECONOMY AND TO FOSTER A NEW AVENUE FOR PROSPERITY.

The shedding of debt during the pandemic—if it continues—would be part of a rebalancing trend after MIDDLE MARKET INSIGHT the postwar era of consumerism. The turning point could Households' growing reluctance to accumulate have resulted from lessons learned from the early 2000s debt might not become a drag if they instead housing bubble and subsequent financial crisis. reduce precautionary savings and wages rise. But the restructuring of household finances is more likely to have resulted from the decline of wage growth after Composition of and long-term trends in the Great Recession, when the manufacturing sector consumer debt was hollowed out, worker representation diminished, and wages and worker benefits barely kept up with normal Mortgages hold the largest share (69%) of consumer levels of inflation. debt and form the backbone of modern American life and wealth accumulation. Housing costs are followed by student loans, which now make up 11% of consumer Household debt as a % of GDP credit; auto loans at 9%; and credit card debt, which holds YEAROVERYEAR PERCENT CHANGES THROUGH Q4 2020 a 5% share. 120 Early 2000s 2010–19 Housing bubble Post-ﬁnancial 100 crisis U.S. consumer credit by type of debt 1970s 1980s–1990s rebalancing Monetary policy Expansion and YEAREND LEVELS IN TRILLIONS OF DOLLARS 80 tightening/ dot.com bubble 1950s–1960s post-Vietnam Postwar and oil crisis 60 consumer-based stagﬂation 16 expansion 2008–09 March 2021 40 Financial crisis/ debt 14 Great Recession (% of total) Other 12 Household debt (% of GDP) 20 3% Student 10 11% 0 Credit card 1951 1961 1971 1981 1991 2001 2011 2021 8 5% Recession indicator Household debt (% of GDP) Auto 6 9% Home equity 4 2% Source: Federal Reserve; BEA; Bloomberg; RSM US LLP

Debt outstanding (US$ tn) Debt outstanding Mortgage 2 69% 0 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Mortgage Home equity Auto Credit card Student Other The takeaway

Source: Federal Reserve; Bloomberg; RSM US LLP We are in a cycle of an inordinate amount of savings pressuring the returns on investment lower and The largest increase in the composition of debt has been moderating wages, inflation and economic growth. in student loans, which grew from 5% of total credit in Whether this era of belt-tightening continues might 2008 to their 11% share in 2021. Home equity lines of depend on the ability of the government to invest in a credit—which were once so popular and in 2008 held a 6% re-imagined economy and to foster a new avenue for share of total consumer credit—now hold a 2% share. prosperity. But re-imagining a 1950s economy is no solution—for today or for the long term. •

RSM | THE REAL ECONOMY | 9 WHAT’S BEHIND THE DECLINE IN 10-YEAR TREASURY YIELDS? BY JOSEPH BRUSUELAS

THE YIELD on 10-year Treasury bonds has been on a 3. Increased demand for bonds: There is a recognition that roller coaster since reaching its recent peak of 1.74% on Treasury bonds provide a safe return in an increasingly March 31, dropping below 1.50% in late June. risky economic and national security environment.

If the initial move up to that peak can be rationalized as a 4. Productivity: Improvement in some of the sectors response to the risks around higher growth and inflation, hit hardest by the pandemic, along with working from then the move below 1.50% in the midst of an economic home, will most likely result in re-optimized working recovery involves a resetting of those concerns. arrangements and a strong medium-term increase in productivity, lifting wages and living standards. (See “Why The factors in this down cycle likely include: working from home will stick” from the National Bureau of Economic Research.) 1. Politics: Passing an infrastructure package becomes more difficult every day, making a multitrillion-dollar Regardless, sub-2% interest rates are not what a package less likely. healthy economy would support, and suggest the need for sustained support from the fiscal and monetary 2. Inflation expectations: Inflation is a feature of the authorities. An infrastructure package that increases the initial post-pandemic recovery and not a significant risk, productivity and competitiveness of the U.S. economy as professional investors appear to be backing away will pay for itself when interest rates are this low. from the inflation trade and the possibility of a return to 1970s-style inflation.

10 | JULY 2021 10-year interest rates Growth concerns, inflation risks and WEEKLY YIELD OF 10YEAR TREASURY BONDS interest rates

3.50 November 2018 Confidence in the recovery has nearly eliminated the Trade war and 3.00 pre-pandemic peak perceived risk of economic collapse and deflation. At of 3.2% April 2021 Post-pandemic 2.50 peak of 1.7% the same time, guidance from the Federal Reserve 2.00 consistently calls for low-for-long money market rates.

Yield (%) Yield 1.50

1.00 If all goes to plan, the result will be an economy that can

0.50 support higher long-term interest rates, while monetary

0.00 policy pressures short-term bond yields lower. That 2016 2017 2018 2019 2020 2021 would create a steep yield curve out to 10 years that Maturity would be conducive for bond trading as an alternative to Source: Bloomberg; RSM US LLP riskier investments in other asset classes.

Changes in real yields But there are never straight lines in asset pricing. A recent adjustment in the term premium priced into 10-year The increase in inflation to 5.0% in May from 4.2% in April Treasury yields, and the decline in expectations for short- has pushed the real (inflation-adjusted) yield on 10-year term rates over the next 10 years, both reflect a rethinking Treasury bonds even lower, to negative 3.5%. The goal of the recovery’s trajectory. of the monetary policy is to facilitate investments by pressuring interest rates lower. A negative real-yield Expectations and risk components of 10-year yields curve and expectations for a growing economy and EXPECTATIONS OF SHORTTERM RATES AND THE TERM PREMIUM BUILT INTO 10YEAR TREASURY YIELDS normal levels of inflation will allow those investments to be paid back in inflation-depreciated dollars. 8 December 2008 December 2018-July 2020 7 Depth of financial crisis: Trade war/COVID-19 Unanchored expectations and expectations of lower Changes in the real (inflation-adjusted) U.S. Treasury 6 of risk short-term rates and 5 increasing risk of deflation yield curve since before the coronavirus 4 TREASURY YIELDS MINUS INFLATION AS OF DEC. 31, 2019, AND JUNE 10, 2021 3

Yield (%) Yield 2 1 1.00 Money- 30-year 0 market 5-year 10-year 0.00 rates -1 -2 -1.00 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 -2.00 10-yr Treasury yield 10-year short-rate expectations 10-yr term premium

-3.00 Yield (%) Yield Source: FRBNY; Adrian, Crump and Moench; Bloomberg; RSM US LLP -4.00

-5.00 2-year Prices are increasing, which should be a welcome sign of -6.00 0 5 10 15 20 25 30 increased demand and normal economic activity. Inflation Maturity expectations have been stable both during the pandemic 12/31/2019 6/10/2021 and as the recovery has taken hold. That reflects both Source: Bloomberg; RSM US LLP confidence that the monetary authorities will know how to handle inflation pressures should they arise, and the Nominal and real U.S. Treasury yield curves uncertainty regarding the fiscal response to the recession NOMINAL TREASURY YIELDS AND INFLATIONADJUSTED YIELDS AS OF JUNE 10, 2021 and the speed of the recovery.

3.00 The Philadelphia Fed’s ATSIX estimate of inflation Money- 30-year 2.00 market 10-year expectations for the next 10 years increased only rates 5-year 1.00 2-year slightly, to 2.30% in May from 2.10% last August. We 0.00 regard the latest tick higher as a reaction to what -1.00 economists consider to be transitory price increases -2.00 Yield (%) Yield because of pandemic production shortages and supply- -3.00 -4.00 chain bottlenecks. -5.00 -6.00 0 5 10 15 20 25 30 Maturity Nominal Real

Source: Bloomberg; RSM US LLP

RSM | THE REAL ECONOMY | 11 The Fed has said that because inflation and demand have When will the economy support higher been abnormally low for so long, it will tolerate inflation interest rates? rates of greater than its 2% target before it undertakes rate hikes. We anticipate the inflation rate moving higher Because of the structural shifts in the global economy— than 5% this summer until 2020 base-year effects, automation, the advent of the global supply chain, and or the comparisons to the low levels of a year ago, are the adaptation of inflation targeting by central banks— no longer a factor. And by the time children are back the expected return on investment has trended lower, in school, the supply-chain issues will begin to work particularly in the aftermath of the financial crisis and the themselves out and consumers will begin turning to Great Recession. The developed economies arguably can other available choices. no longer support the high real (inflation-adjusted) rates of return of earlier decades. Our expectations are that 10-year yields will approach 2% before the end of the year as vaccinations continue for According to an analysis by Kathryn Holston, Thomas younger people and life gets back to normal. Even then, Laubach and John C. Williams at the San Francisco Fed, yields would still be below the trend decline in interest the natural rate of interest is defined as “the real short- rates shown in the analysis below. A break above 2% term interest rate that would prevail absent transitory would be a sign of a healthy and competitive economy disturbances.” According to another analysis, by Thomas and would go a long way to thwarting the development of A. Lubik and Christian Matthes at the Richmond Fed, the bubbles in other asset classes. natural rate of interest is a hypothetical interest rate that is “consistent with economic and price stability.” 10-year yields, the CPI, and inflation expectations Holston, Laubach and Williams wrote that the natural rate 8 provides a benchmark for monetary policy. Real short- December 2008 December 2018– 7 Depth of financial crisis: October 2020 Unanchored expectations Trade war/COVID-19 term rates below the natural rate indicate an expansionary 6 of risk and expectations of lower 5 short-term rates and policy, while real short-term rates above the natural rate increasing risk of deflation 4 indicate a policy of contraction. As Lubik and Matthes 3 (%) 2 wrote, “it is not the level of the natural rate that matters 1 but its value relative to other interest rates.” 0 -1 During the decade-long recovery from the Great -2 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Recession, U.S. real short-term interest rates have been 10-yr Treasury yield Inflation rate (6-mo avg) Inflation expectations (10-year) negative and below the natural rate estimates on all but a few occasions. That indicates monetary policy has been Source: Philly Fed; Bloomberg; RSM US LLP accommodative, even during the period of interest-rate normalization near the end of the recent business cycle Fed funds rate and 10-year yields that drew so much criticism. 10YEAR YIELDS AT THE END OF FED RATEHIKE EPISODES In our opinion, the decline in the natural rate of interest 8.0 End of 1990s End of 2000s housing End of post-financial tech boom market boom crisis recovery 7.0 from the Great Recession and the concurrent secular 6.0 decline in 10-year yields and gross domestic product 5.0 growth—which we show in the figures below—suggest 4.0 structural issues in the economy that we have yet to 3.0 Yield (%) Yield 2.0 overcome. Despite the best efforts of the monetary 1.0 authorities, the fiscal authorities need to do more if 0.0 the United States is to avoid becoming the Japan of -1.0 1991 1996 2001 2006 2011 2016 2021 this century. 10-yr Treasury yield Fed funds rate

Source: Bloomberg; RSM US LLP We need to create the foundation for the next economy, both in physical terms—through traditional structural improvements such as rethinking the energy and broadband grids—and in intellectual terms, by addressing the deficiencies in education and the health of the labor force. The United States is no longer the leading exporter in the world. Simply rebuilding the old economy is shortsighted and a waste of resources.

12 | JULY 2021 Purchases of Treasury bonds by foreign investors MIDDLE MARKET INSIGHT continue to increase. We attribute this to increased We anticipate the inflation rate moving higher commercial demand for parking profits (from trading with than 5% this summer until 2020 base-year American importers) in U.S. securities, and the implied effects, or the comparisons to the low levels of safe-haven demand of those purchases. Increased a year ago, are no longer a factor. demand in any form will help keep a lid on increases in yields and will allow the Fed to think about reducing its purchases of long-term bonds. In our estimation, an increase in the natural rate • in the first quarter isa positive first step toward U.S. high-yield bond spread normalization of interest rates and offers the potential BLOOMBERG BARCLAYS U.S. CORPORATE HIGHYIELD SPREAD for a sufficient return on investment and the re- OVER TREASURY BONDS imagining of the U.S. economy. 20 18

Real interest rates and the natural rate of interest 16 December 2008 March 2020 Depth of ﬁnancial crisis: Height of pandemic 3MONTH TBILL RATE AND 10YEAR TREASURY YIELDS MINUS INFLATION 14 Unanchored expectations 12 of risk 10 12 8 10 Secular decline in the 2008-2021 Laubach-Williams natural Low-for-long era 6 8 rate of interest of interest rates 4 6 Spread (percentage points) (percentage Spread 4 2 2 0 0 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021

Real yield (%) Real -2 High-yield spread High-yield spread (5-yr avg) -4 1970s -6 Stagﬂation era Source: Bloomberg Barclays Indices; RSM US LLP -8 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021 Real 3-mo rate Real 10-yr yield Natural rate of interest Bid-to-cover ratio of 5- and 10-year U.S. Treasury bonds 13WEEK AVERAGE AND LATEST RATIO OF AMOUNT OF BIDS RECEIVED Source: Laubach-Williams; Bloomberg; RSM US LLP TO BONDS SOLD AT AUCTION

4.0 Long-term trends in real GDP growth and real 10-year 2001 2008–09 2020–21 Dot.com Global ﬁnancial Pandemic interest rate 3.5 bust crisis/Great Recession 10YEAR TREASURY YIELDS MINUS INFLATION 3.0

2.5 10 8 2.0

6 ratio Bid-to-cover Successful auctions are 4 1.5 considered to have a minimum 2 bid-to-cover ratio >= 2 0 1.0 (%) 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 -2 Recession indicator 5-yr bid-to-cover 10-yr bid-to-cover -4 -6 -8 Source: BEA; Bloomberg; RSM US LLP -10 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021 U.S. real GDP (YOY %) (smo) Real 10-yr yield (6-mo avg) 10-year yields and foreign purchases of U.S. Treasury bonds Source: BEA; BLS; Bloomberg; RSM US LLP

9 100 300 8 March–December 2020 Bond market developments Drop in foreign purchases as 500 global commerce grinds to a halt 700 7 during the pandemic 900 The recovery, fueled by the confidence in the vaccination 6 1,100 5 1,300 program, is evident in the spread between high-yield 1,500 4 1,700 Yield (%) Yield corporate bonds and Treasury bonds. A growing economy 3 1,900 2,100 indicates diminished risk of corporate default, and a 2 2,300 2,500 reduced premium required to hold those bonds. 1 2,700 scale) (US$ bn) (reverse Purchases 0 2,900 The bid-to-cover ratio has remained comfortably above 1991 1996 2001 2006 2011 2016 2021 10-yr Treasury yield (%) Foreign purchases of Treasurys (US$ bn) (3-mo avg) (RHS) 2, an indication of the demand for Treasury securities despite their lack of return relative to other assets with Source: U.S. Treasury; Bloomberg; RSM US LLP more risk.

RSM | THE REAL ECONOMY | 13 THE ALTERNATIVE ALTERNATIVE ANALYSIS FOR INFORMED MIDDLE MARKET DECISION-MAKING

RISING RENTAL MARKET IS TIED TO LIMITED SUPPLY, NOT AFFORDABILITY BY TROY MERKEL

HIGHER HOME PRICES in the United States are not The National Association of Realtors Housing Affordability fueling the rental market, despite media reports to the Index, which compares current mortgage rates and contrary. Instead, would-be buyers are seeking rentals median home prices to median household income, shows due to the limited supply of homes for sale in what that buyers have more than enough cash to purchase is expected to remain a hot market throughout the the homes they are bidding on now. The March 31 reading remainder of this year. of 116.4 means that the average family planning to buy a house has 116% of the income required for a mortgage, The primary driver of the housing boom has been first- assuming they put 20% down for a home in the median time homebuyers, often coming from urban apartments price range. Compare that to the sub-90 index reading to the suburbs in search of land and a home office. that prevailed for much of the 2000–2009 period, when Historically, the largest barrier to entry for this group is overly lenient lending and subprime mortgages helped the ability put down a cash equivalent of 10% to 20% of bring on the Great Recession. the value of a home. Without the benefit of selling an often-appreciated existing home, these buyers can find Limited home supply it difficult to enter the realm of homeownership and thus they remain renters. Pandemic-induced constraint is the real culprit in the search for the perfect home. Many existing homeowners But the odd silver lining of an otherwise devastating are not selling; more aging baby boomers are opting pandemic has been more cash on hand for many. When to age in place, building on a pre-pandemic trend that we look at current household economics, consumer may have been exacerbated by COVID-19 fears. Those balance sheets are strong, with pent-up demand ready concerns may also be prompting owners overall to stay to be unleashed following more than a year of hunkering put. Nationwide inventories of existing homes for sale down with limited discretionary spending. The U.S. have remained between 880,000 and 990,000 units for personal savings level, while down from an unprecedented the year, well below a prior low of 1.38 million in December pandemic peak of 26% of income in June 2020, remains 1994 and pre-pandemic levels of more than 2 million strong at 14.9%, still above the nearest historical high in annually in recent years. 1975. Elevated savings means that down payments for homes are more available.

14 | JULY 2021 THE PRIMARY DRIVER OF THE HOUSING BOOM HAS BEEN FIRST-TIME HOMEBUYERS, OFTEN COMING FROM URBAN APARTMENTS TO THE SUBURBS IN SEARCH OF LAND AND A HOME OFFICE.

had remained since December 2020 when the Trump MIDDLE MARKET INSIGHT administration reduced it from 20% following a protracted Pandemic-induced constraint is the real culprit global tariff war. A reduction in tariffs is one of the fastest in the search for the perfect home as many ways the federal government can ease cost pressures in homeowners decide not to sell and aging baby the housing market. boomers choose to age in place. Meanwhile, affordability is the driving force behind a proposal in President Biden’s massive infrastructure New home prices are up 20% since last April to a national plan to include funding to rehabilitate homes in low- and average of $372,400, according to the U.S. Census Bureau. middle-income neighborhoods and build new ones; the Limited availability of key materials such as lumber hotly debated plan calls for adding 2 million homes in such and precious metals like copper, as well as a dearth of neighborhoods over the next decade. suitable building lots, have driven up costs and hampered developers’ efforts to retrofit existing homes and build Such measures are beneficial in the short-term, but new ones. The escalation in the price of lumber alone— they represent a Band-Aid approach to the pervasive which saw futures trading as high as $1,686 per thousand challenges caused by inconsistent zoning and permitting board feet at the beginning of May—has added $36,000 laws across the country. The transformative piece of to the average price of a new U.S. home, according to the Biden’s infrastructure legislation for residential real estate National Association of Home Builders. tackles those issues. The proposal would set up a $5 billion fund for local governments to fund new schools and The incredible market volatility has caused homebuilders roadways, provided that cities ease zoning laws to permit to be cautious as they fear snarls in the supply chain that more multifamily housing. could leave them in a bind with excess inventory. There appears to be some relief in the lumber market, as futures While some may contest the merits of allowing multi- eased to $945 per thousand board feet as of June 17; even unit housing in neighborhoods predominantly populated so, lumber remains priced at more than three times year- by single-family homes, few would dispute the fact that ago levels. the nation’s fractured and inconsistent zoning laws are a major impediment to development. The not-in-my- Government impact backyard mentality in some areas has resulted in highly stratified upper- and lower-income segmentation of Add to these challenges a volatile tariff environment communities. It is critical that the government work to and there is no clear outlook for when home prices may provide cohesive and consistent regulations to allow the ease. In May, the Biden administration increased the levy housing market to meet growing demand. on lumber from Canada to 18.32% from 9%, the level it •

RSM | THE REAL ECONOMY | 15 INDUSTRY SPOTLIGHT

FINANCIAL SERVICES SPAC IPO MARKET PAUSES AS INVESTORS AND REGULATORS REEVALUATE BY KENNEDY CHINYAMUTANGIRA

INITIAL PUBLIC OFFERINGS of special purpose Deﬁance Next Gen SPAC Derived ETF acquisition companies (SPACs) have almost ground to a halt, a rapid and spectacular reversal of one of the hottest $36 trends in 2020 and the first quarter of 2021. SPACs’ share $34 price performance—as reflected by the Defiance Next Gen $32 SPAC Derived Exchange-Traded Fund, which consists of $30 hundreds of SPACs at various stages of the investment $28 cycle—dipped on May 13 to its lowest level since the fund price Share $26 debuted Oct. 1, leaving questions in place of the buzz. $24 $22

Now that the SPAC boom and its mid-February crest are $20 behind us, what should we make of the current pause? 1/1/21 2/1/21 3/1/21 4/1/21 5/1/21 How do we make sense of the slowdown? What forces will 10/1/20 11/1/20 12/1/20 shape what happens next? Source: Bloomberg; RSM US LLP

The pause in new SPAC IPOs may well turn out to be a are suitable targets to merge with a SPAC—may be good positive for the evolution of this public listing alternative. for rebalancing the market. Some enhanced regulatory The wintertime explosion of volume and dollar value scrutiny may also bring about investor protections and of new SPAC IPOs may have simply run too hot to be an alignment of interest with SPAC sponsors that could sustainable. A steady flow of SPAC IPOs at a slower pace— enable both retail and institutional investors to invest in one that matches the supply of private companies that SPACs with more confidence in the long run.

16 | JULY 2021 A STEADY FLOW OF SPAC IPOS AT A SLOWER PACE—ONE THAT MATCHES THE SUPPLY OF PRIVATE COMPANIES THAT ARE SUITABLE TARGETS TO MERGE WITH A SPAC—MAY BE GOOD FOR REBALANCING THE MARKET.

The change may force some existing SPACs to restate MIDDLE MARKET INSIGHT their financial statements, which generally is a negative Investors know the SEC is watching closely event for a public company. It also could slow the and probably will take additional steps to bring registration of new SPACs seeking to complete an IPO, order to the market and curb any speculative as they may need to amend existing filings before their behavior. registration statements can be declared effective by the SEC. The warrant accounting change does not have any direct impact on the economics or cash flows of the To be clear, SPACs are unlikely to disappear from investment vehicle and therefore is likely not the sole capital markets despite the recent setbacks and some contributor to the slowed pace of SPAC IPOs. headwinds in the future. With more than 400 active SPACs looking for targets after the fundraising frenzy The SEC also has vocalized its concerns pertaining to of 2020 and first quarter of this year, there is plenty of certain features of the de-SPAC transaction, specifically dry powder—about $178 billion as of mid-April, according the practice of presenting forward-looking statements to to IHS Markit—looking to close deals before the 18-to- entice investors to vote in favor of the merger transaction. 24-month deadline by which a SPAC has to complete a reverse merger with a private company to make it public. John Coates, the acting director of the SEC’s Division of Corporation Finance, released a statement April 8 Existing SPACs continue to announce merger arguing that the de-SPAC transaction is, in fact, the transactions, although there are some indications that transaction by which the target company goes public the soured sentiment may have slowed the pace and and, as such, may be viewed as its IPO. In the traditional tempered the ease of locking down financing from private IPO process, presenting forward-looking projections investment in public equity (PIPE). PIPE deals inject more is prohibited. Coates’ statement portends possible capital in these so-called de-SPAC transactions in order regulation concerning permissible use of financial to facilitate the acquisition of targets valued at price tags projections and potential liability risk for dissemination even larger than the cash raised from the SPAC IPO and to of such information. inject cash into the operating business. Aside from the SEC’s overhanging magnifying glass, the Meanwhile, the future of SPAC IPOs is less clear. While reasons for SPACs’ diminished share price performance several drivers have dampened interest in the current are manifold. The drop from the mid-February peak to environment, the threat of more regulatory scrutiny early March is closely connected to the drop in growth might have relatively long-lasting effects. stocks, which was driven by market fears that interest rates would rise as a result of increasing expectations The Securities and Exchange Commission (SEC) fired a for inflation. In fact, the growth and tech-heavy Nasdaq warning shot on April 12 when it clarified how to interpret Composite Index followed a similar trajectory over guidance about how SPACs account for warrants, a the same period. SPACs, by the nature of the target key feature of how SPACs incentivize and attract initial companies they pursue, closely resemble growth stocks. investors. The new treatment may require that warrants be recognized as liabilities instead of a component of equity, although fewer firms appear to be impacted than initially expected. The resulting accounting issues are not necessarily difficult to overcome, but they can be time-consuming.

RSM | THE REAL ECONOMY | 17 THE SECURITIES AND EXCHANGE COMMISSION FIRED A WARNING SHOT WHEN IT CLARIFIED HOW TO INTERPRET GUIDANCE ABOUT HOW SPACS ACCOUNT FOR WARRANTS.

From mid-March onward, though, SPAC stocks have SPAC activity May 2020 to May 2021 continued their downward slide as retail investors’ interest retreated. Retail investors had been one of the driving $60 200 forces behind the SPAC surge. Many searched for the $50 next big startup in novel industries such as space travel, 160 $40 electric vehicles and other related technologies. 120 $30 80 SPACs versus Nasdaq Composite Index $20 Oﬀer size ($bn) Oﬀer

40 Number of transactions $10 14,500 $36 14,000 $34 $0 0 13,500 $32 1/21 2/21 3/21 4/21 5/21 13,000 5/20 6/20 7/20 8/20 9/20 10/20 11/20 12/20 $30 12,500 Oﬀer Size ($B) Number of transactions $28 12,000 $26 11,500 Source: Bloomberg; RSM US LLP 11,000 $24 10,500 $22 10,000 $20 The extent to which retail investors remain interested in SPACs is just one of several factors that will determine 1/1/21 2/1/21 3/1/21 4/1/21 5/1/21 10/1/20 11/1/20 12/1/20 the duration of the current pause and, beyond that, share Nasdaq Composite Index SPACs (Deﬁance Next Gen SPAC Derived ETF) price performance. Source: Bloomberg; RSM US LLP In general, an economic recovery over the next 16 to 24 months that supports a broad stock market rally would Proponents of SPACs have touted them as a vehicle put investors more at ease allocating to SPACs. Retail for democratizing investment in startups, which investors that see stock prices stabilize in a growth traditionally has been within the purview of only venture environment could have their confidence in SPACs capitalists and other deep-pocketed investors. The repaired. Then again, they also would have attractive initial retail interest in SPACs reflected that position, investment alternatives. aiding a rise in SPAC stock prices that at times seemed speculative. Some SPACs soared to dizzying heights As that dynamic evolves, investors will continue to on the back of little market-moving information. Even question what else the SEC is going to do about SPACs. celebrities started getting in on the SPAC action. Lest Investors know the commission is watching closely and retail investors be drawn to SPACs by star power instead probably will take additional steps to bring order to the of sound investment practices, the SEC’s Office of market and curb any speculative behavior. We will also Investor Education and Advocacy on March 10 published have to see what happens when groups get past the an investor alert that included a boldface and italicized warrant-accounting speed bump. sentence that reads: “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests Ultimately, the hope is for dollars to be deployed more in it or says it is a good investment.” thoughtfully toward worthy targets—growth companies that are more stable than speculative. If SPAC investment activity returns to the level of last June to November, it could be sustainable in the future of capital markets.•

18 | JULY 2021 MIDDLE MARKET TREND WATCH

IN MMBI SURVEY, A CALL TO SHORE UP THE NATION'S INFRASTRUCTURE

AFTER DECADES of watching America’s infrastructure decline, senior executives at middle market businesses are pushing to fix the nation’s basic systems, according to a recent RSM US LLP survey of senior executives in middle market businesses.

In a striking shift in outlook captured by the proprietary RSM US Middle Market Business Index survey, these executives agree that the state of the nation’s infrastructure is hampering economic growth, not only at the national and the local levels, but also within their own organizations.

Here are some key takeaways of what executives told RSM in the survey:

Lawmakers will, at long last, address the issue.

The state of the nation’s infrastructure is 64% believe that meaningful action hampering economic growth. will take place in the next three years that will result in tangible infrastructure enhancements. 63% told RSM that the nation’s ailing infrastructure is restricting growth of the national economy. Time has run out, and businesses need to act. 61% said it restricted growth of their local economies. 73% said they would make capital investments to expand their infrastructure in 54% said it hurt their own the next three years. businesses. 63% are currently taking active steps to reduce their carbon footprint.

For more on the middle market and infrastructure, read the full report.

RSM | THE REAL ECONOMY | 19 For more information on RSM, please visit rsmus.com.

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