The Housing Crisis in California: A Simple Explanation

by Mark Schniepp
August 2019

What’s the Cause of the Housing Crisis?

It’s being called a crisis because many people can’t obtain housing at current prices. But actually when this happens, it’s a crisis for the person seeking housing and a bonanza for the owners of rental and for-sale housing.

The law of supply and demand typically always prevails in markets that are mostly unregulated.

So here we are in the mostly unregulated housing market and due to strong demand and little supply growth, prices move exactly to where they should go, which is up. And why should they go up? To ration the existing housing and allocate it to those who can pay (which is how we allocate most goods in a capitalistic economy).

This sounds callas to many people, because there is an expectation that housing is a basic necessity like air and water and it should be more affordable. Well, it generally is. But not in Coastal California where (1) everyone wants to be, (2) where most of the jobs are, and (3) where building new housing is both limited and difficult (or near impossible) to navigate through the permitting process.

You can find much much much more affordable housing and plenty of it in Kern County, or Fresno County, or Colusa County, or Tucson, Little Rock, or Kansas City. There is no crisis in these housing markets and in the majority of the country.

But is the lack of supply the only reason for high prices in California, or I should say, coastal California? No. But the limits on supply are the principal cause.

There is an asymmetry between the growth of supply and the growth of demand. Growth of supply has lagged demand for a major part of the last 40 years in California.

Why? Because there have been increasing constraints on the development of housing imposed by legislation and court rulings since 1970.

CEQA (the California Environmental Quality Act) was enacted in 1970. In 1972 a California Supreme Court decision required an EIR for private development projects including housing projects. An EIR discloses the possible adverse effects on the environment of new development projects.

CEQA enables anyone the ability to litigate against homebuilding (or just about any building) in California. Lawsuits filed under CEQA against housing projects immediately delay them, increase their cost and increase the probability that they won’t get approved or built. Either that or the project is downsized. Therefore, less housing than originally intended is built, and this together with the efforts required to assure protection to the environment, increase the cost of housing.

In 1972 the City of Petaluma established a growth control on housing units, preventing the construction of approximately 50 to 67 percent of the housing units that would otherwise have been built in response to normal market demand. The City was sued. The suit ultimately made its way to the U.S. Supreme Court after lower courts found that builders were in fact injured by the City’s restrictive housing program. The highest court upheld the growth control.

This led to more cities adopting controls particularly in Northern and Southern California. And most coastal California cities have effectively restrictive measures embedded in their housing entitlement processes.

Then there are the development fees on housing that increase construction cost, and these fees are notoriously higher in California than in any other state, and by a magnitude of 2 or 3 or 4 to 1.1 In the referenced study, it was found that development fees increase the cost of housing in California by 18 percent.

There is therefore significant inertia either against the development of housing, or towards driving up the cost of housing in California.

Development fees are unlikely to go away, and CEQA is unlikely to be changed.

The desirability of coastal California increases demand and clearly, the growth of demand has been disproportional to the growth in the supply of housing. Consequently, predictable outcomes result with the price of housing. The great economic expansion of the 21st century has exacerbated that demand due to the prolific surge in job opportunities that have been created in California, and especially in the Bay Area and Southern California.

That’s it, a simple explanation of the housing crisis in less than 800 words.

What Can You Do About It?

Two things: (1) Wait for the next recession and hope it actually will soften the demand for housing (which recessions typically do), or (2) Move to Kansas City.

Even if the current level of demand abates, it’s unlikely to significantly impact housing prices and rents in Coastal California, but that all depends on the severity of the recession.

———-

1 National Impact Fee Survey: 2015, by Clancy Mullen, Duncan Associates, http://www.impactfees.com.

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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The Longest Expansion in U.S. History

by Mark Schniepp
July 8, 2019

On July 1, the U.S. economy quietly “celebrated” the longest consecutive spell of economic growth on record: 10 years and one month. The expansion officially started in mid-2009, following the horrific Great Recession, and no end is currently in sight.

We have already experienced the longest bull market on record in stocks during the expansion, and we continue to set a new record every month for continued positive job creation.

The current 121-month growth cycle edges out the previous record expansion of the 1990s that ended with the start of the 2001 recession, after 120 expansive months.

Everyone says that while the length of the expansion is remarkable, the strength of the expansion is not, and has in fact represented the slowest rate of growth over the last 70 years averaging 2.3 percent per year since 2009.

But it’s clear from the chart that the nation has shifted to a new growth path of GDP during economic expansions. Is growth really lackluster, or has it merely been replaced with the understanding that today’s $20 trillion economy won’t likely grow as fast as the $7 trillion economy that prevailed in 1975?

The 2 Percent Economy

We’ve been in a 2 percent per year expansion for 10 years. But so what? What’s to criticize? We are at full employment. Wages are rising faster than the rate of inflation. Inflation is historically low. Interest rates are historically low. Your car payment is low. If you financed a home purchase between 2010 and 2015, your house payment is low. If you already owned a home before that, your payments are probably even lower.

Technology has given you extraordinary freedom with smart cell phones and you are connected to everything and everybody practically 24 hours a day. Uber has become pervasive and is one of your best friends, and Amazon delivers you everything you need in 2 days or less. All this has occurred during the 2 percent economic expansion.

The End is Near

There have been numerous predictions of the onset of recession over the last 5 years, but no real consensus. And sure enough, the economy marched on. There is now a growing consensus that economic growth will slow from this moment on, ultimately manifesting in a recession.

A poll by the National Association of Business Economists in May showed that 60 percent of respondents expect a recession next year, even though there is not much evidence that economic conditions are weakening yet.

Corporate profits have weakened, but the stock market continues to set new record highs (the most recent record occurred on July 3, 2019).

Housing has weakened in all regions of the U.S., but home prices continue to rise, and the recent sharp decline in mortgage rates has produced another refinancing boom.

The trade war is not helping U.S. manufacturing, but the trade war alone is unlikely to push the nation’s economy into negative growth, unless tariffs and counter-tariffs suddenly escalate. This however is a low probability scenario. Even so, the Fed is poised to cut rates given this possibility (or other signs of weakness), and this would boost the outlook for rate-sensitive sectors including housing and automobiles.

The dreaded flattening of the yield curve has now become more worrisome because the spread between the 3-month and 10-year treasury yield has been negative for more than 6 consecutive weeks. A negative spread lasting a quarter or two is nearly a certain predictor of recession, though eminent doom is often a year or more away.

We have been reporting extensively in recent months on the U.S. labor markets, the housing market, interest rates, and the possibility of recession. We’ve been on a vigilant recession watch for over a year. But the aggregate indicators are either not breaking down or not breaking down enough for us to sound the alarm. And many indicators like the stock market, the labor market, and consumer spending continue to show unprecedented strength.

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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The California Unemployment Rate is Rising Again

by Ben Wright
June 2019

After 8 years of persistent improvement, the California unemployment rate began to drift upward in January 2019. A rising unemployment rate typically indicates that business conditions are deteriorating and companies are slashing jobs, and once the unemployment rate begins to rise, the economy often falls into recession within a year.

So is the California labor market indicating that a recession is imminent? Will mass layoffs begin sometime in 2019 or 2020? Not necessarily. The unemployment rate is now increasing because there are abundant opportunities to find a job, wages are rising, and people who had given up on finding a job are now returning to the workforce.

Recruiting Remains Extraordinarily Difficult

Even though the unemployment rate is rising, the job market is still excessively tight, and hiring managers are having problems finding qualified workers. Throughout California there are only 1.3 unemployed residents for every job opening, and in some regions there are more openings than people available to fill them.

The most extreme example is the Bay Area where there are 210,000 job openings but only 104,000 unemployed residents. Even if every applicant in the Bay Area was perfectly qualified for an open position, half of all jobs would still go unfilled.

In such a scenario, companies typically recruit from other cities and increase wages to poach employees from other firms. Both of these strategies are now being deployed, in varying degrees of intensity, across the major regions of California.

Statewide, the median wage increased by 3.5 percent in 2018, and increased much more quickly in some job categories.

In particular, wages are rising at above-average rates for jobs that do not require a college degree. This includes manufacturing, transportation, maintenance, and some healthcare jobs like home health aids and nursing assistants. After the 2007-2009 recession, workers without college training exited the job market in large numbers, but higher wages and fiercely competitive conditions appear to be bringing them back.

Influx of New Job Seekers

The California labor force (the number of people either working or looking for work) is expanding at the fastest rate since 2007. So far in 2019, the state is on pace to get 272,000 new job seekers, and because the job market may not be able to absorb them all, the unemployment rate could continue to move higher.

This is particularly true in the Bay Area, where the number of job seekers is expanding twice as fast as the rest of the state. And as a result, the unemployment rate is rising more quickly as well.

None of this rules out the possibility of a recession. When the unemployment rate gets too low and hiring becomes a challenge, it is difficult for companies to grow and for the economy to expand, meaning that a routine shock, like a stock market decline or government policy error, can more easily knock the economy off course. But in California, the labor market is signaling that times are still good, at least for now.

 

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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Population Growth Slowest in Recorded History

by Mark Schniepp
May 2018

That was the headline in the LA Times on May 1, 2019.

The growth in California’s population between 2018 and 2019 was the lowest since records have been kept, going back to the year 1900.

The population of California is now estimated at 39,927,315 people as of January 1, 2019. The rate of growth over the last year was under 0.5 percent.

Is this good or bad?

It means there will be a slowdown in the pressure to build more housing which is the biggest economic issue in the state right now. So the ongoing slowdown in population growth is welcomed.

The state still needs more housing units, and the simple and obvious evidence of this is their price—to buy or to rent—principally in coastal communities.

But a slowdown in population is what we’ve been observing and expecting for many years. It’s what we’ve waited for. A population decline actually occurred in Los Angeles County last year. It was slight but it did occur. And it’s likely to occur this year and over the next few years especially if the economy hits a soft patch.

Is Negative Population Growth a Concern?

Although the state could use a little of this, we have to be weary of a persistent decline in population that many of the Northern California Counties find themselves experiencing right now. Lassen, Plumas, Sierra, Del Norte, Alpine, and Tuolumne are just some of the counties with persistent declines in population, due largely to the out-migration of the 25 to 44 year old age cohort. As this occurs, there are less workers available to fill jobs needed to provide goods and services to the remaining older populations, aged 65 and above.

That’s not likely to occur in Coastal California or Southern California but a few years of
negative population growth would reduce the growth of demand for housing, and market prices would adjust. But this won’t happen because as prices start to contract populations from outside the state would pour in to buy homes with falling values, and the growth of population would stabilize or increase again. This is akin to a Dutch auction.

Why is Population Growth Slowing Down?

Well, it’s not because there is a lack of jobs here. We have tens of thousands of unfilled positions right now, and it’s only been increasing for the last 5 years.

The usual suspects for slowing population growth are, of course:

  • High home prices due to the dearth of housing
  • High taxes, and
  • Insane traffic, like at the 101 and 405, or on the 101 transition to Interstate 80 in San Francisco, or on the 880 anywhere. And thousands of other spots in the Bay Area and greater Los Angeles metro area.

But There’s Another Reason

The sharp decline in births to millennials. Last year the birth rate in the U.S. dropped to an all time low, meaning millennials just aren’t having children, choosing instead to work and pay off their student loans rather than potential child care costs.[popovernew title=”” button_text=”1” trigger=”hover” style=”top” size=”btn-xs” type=”btn-link” ]The birth rate for women aged 15 to 44 dropped to the lowest recorded level since birth rate tracking began in 1909.[/popovernew]

And the lack of birthing today will ultimately create headaches for baby boomers. The delays in starting families by millennial households precludes the need for them to purchase family housing. And family housing is what the boomer generation owns having raised their family and now wanting to downsize or move to Arizona to play golf.

And what boomers own is not what millennials can afford nor is it what they need, yet.

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Given this reality, the plans of many Boomers to downsize to a downtown area, transplant themselves to a beach or golf community or even to buy into a continuing care retirement community may have to be put on hold – a curious ripple effect in which the lengthening of one life stage for one generation leads to a delay in a life transition for a different generation.

Coughlin, Joseph, “Millennials Aren’t Having Kids”. Forbes, June 11, 2018

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Consequently, price concessions will have to be made by boomers to sell their homes to a more limited home buying demographic that has been reduced by the absence of millennial families today. Now this may change sooner or later, but it’s not changing yet.

So while lack of home building has contributed to high home prices in California and elsewhere, declining population growth and the postponement of family building by millennials may work to lower housing prices.

But, if you’re tired of crowds at the beach, crowds at the bar, traffic on the 101, crowds at Disneyland or Magic Mountain then embrace the lack of new housing and the high costs of housing because that’s the ticket to a slowdown and perhaps even a reversal in population growth.

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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The Housing Outlook for 2019

by Mark Schniepp
April 2019

With the first quarter of 2019 now in the books, we have a clearer picture of how the housing market is likely to move this year. So I’m taking this generous head start in 2019 to forecast 2019, because, frankly, I’m more likely to get it right.

Jobs are the principal driver of the demand for housing and regional home sales. With near unlimited job opportunities right now together with rising incomes, home sales have nevertheless been unimpressive, and in much of California they declined last year.

The demand for rental housing instead has dominated housing choice, as both Millennials and Boomers look to non-ownership housing. That’s why of course so much more apartment product is being built nowadays. Moving boomer households may actually prefer to rent to avoid all those annoying repairs and those big property tax bills in December and April. And Millennials simply don’t have the down payment.

Existing home sales are forecast to remain at muted levels in 2019 and 2020. The fall-out that occurred in 2018 with sales falling 5 percent in California is unlikely to be reversed this year. This late in the expansion, home buyers are reluctant to buy homes at record high prices with the expectation that a recession is coming. There is still the memory of the 2006-2007 housing bubble and the aversion to buying at the top.

While a lack of inventory has been a constraining factor on home sales in recent years, this year inventory is rising, just about everywhere you look. Consequently, with more supply and a reticence to buy, look for softening prices in 2019.

 

A meaningful correction in prices is not forecast because the economy will remain strong, incomes will continue to rise, and many households will still elect to buy, especially as interest rates surprisingly move lower.

Year to date, the statewide median selling price is about 2 percent higher than year ago values, though there are price corrections occurring in Ventura, Orange, Los Angeles, San Francisco, Monterey, Santa Clara, and Sonoma Counties.

Our base forecast for home price appreciation does moderate however, and the alternative forecast turns negative if sales fall off further. However, a major correction in prices is unlikely to occur in 2019.

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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An Inverted Treasury Yield Spread and Recession: A Short Story

by Mark Schniepp
March 2019

I mentioned this in the previous February newsletter but it’s worth exploring it further because “recession” has become a popular concern and this particular indicator has been relatively fail-safe as an antecedent for recession over the last several economic cycles. It should be noted however that most economic indicators are not signaling weakness in the economy yet.

What Does an Inverted Yield Spread Mean?

An inverted yield curve is an interest rate environment in which long-term debt has lower yield than short-term debt of the same credit quality. It occurs when the 10 year U.S. treasury bond yield less the 3 month U.S. treasury bill yield turns negative. This is the conventional spread that is typically evaluated. Alternatively, other analysts use the yield spread between the 10 year and the 2 year T-bill.

An inverted yield curve predicts lower interest rates in the future. The belief that the economy is weakening moves investors to demand longer-term bond yields to lock in those rates. This sends the yields down. Since investors are not buying short term bills, their yields ultimately rise. And since the fed has raised the federal funds rate several times, short term rates have risen.

Clearly then, inverted yield curves occur when investors are bidding for longer-term bonds and thus driving down their yields because they are pessimistic about the short-term prospects for the economy.

There is pretty convincing evidence that inverted yield curves, with short rates higher than long rates, predict recessions. Presently the yield curve is not inverted regardless of which spread we use. There will be a prediction of recession when the spread inverts usually for a period of 2 to 3 months.

Is the Yield Curve Actually Close to Signaling a Recession?

Yes the spread is on a path heading straight for an inversion. We are near to that situation but we’re not there yet. If it remains on its current rate of trajectory, an inversion would occur this summer. However, right now the yield curve is not inverted regardless of which spread is used: 10 year less the 3 month, 10 year less the 2 year, or 5 year less the 3 month. Importantly, there is only a prediction of recession when the T-bill yield on shorter term debt exceeds the yield on longer term debt. So at this moment there is no forecast of an imminent recession in 2019 or 2020.

Furthermore inversion does not spell immediate doom. The evidence is that inverted yield curves, with short rates higher than long rates, predict recessions. Over the last 5 business cycles, the average recession occurred 11 months after the spread turned negative. The range is between 5 and 17 months.

When Will There Be a Recession?

While there will be a recession at some point, the issue is always when.

To repeat, currently the yield curve is not yet predicting recession but moving towards the point where recession would seemingly be imminent sometime over the next 24 months. And though an inverted yield curve has been a consistent predictor of recession since the 1960s, there is always the possibility of a false signal.

I think it’s also important to consider other indicators in the economy, such as the leading indicators index and the Risk of Recession index. Also consider the movement in stock market values.  None of these indicators is predicting recession this year.

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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Cracks in the Economy and the Next Recession

by Mark Schniepp
February 2019

Last month I presented the outlook for 2019 and a recession was not part of it. Now just to be clear, a recession is coming, not this year but early in the next decade. It’s unknown what event or issue will serve as the tipping point, but any one or combination of conditions could weaken the economy and make it vulnerable to a downturn in growth.

The candidates I’ve been watching closely are:

  • The headwinds in retail
  • The trade wars
  • Slowing GDP growth in China
  • The stock market correction
  • Faltering home sales
  • Interest rates, and
  • Credit spreads

Warning Signs

The Trade war has affected both agriculture and some manufacturers.

General Motors announced in December that it was slashing production at American factories. GM pointed to tariffs on steel and aluminum in its recent decision to close several factories and cut thousands of jobs.

The recent sell-off in the stock market was the sharpest since September 2011. The tech giants (Facebook, Amazon, Alphabet (Google), Apple, and Netflix have lost nearly a trillion dollars in market value since September.

The turbulence is perhaps an early warning sign by investors who are worried about the sustainability of current economic growth in view of

  1. Fed interest rate policy, and
  2. A noteworthy deceleration of the Chinese economy

Apple is cutting iPhone production to China, due to a weaker economy there. This is a bellwether sign. China is the third largest market for Apple, behind the U.S. and Europe.

Furthermore, tight labor markets are pushing wages and salaries higher, and this is impacting corporate profitability. Profitability reduces earnings, and lower earnings result in lower stock prices. Lower stock prices reduce household wealth and I’ll discuss that further below.

The Retail Sector

Consumer behavior is changing and the way we buy goods is going through a dramatic shift. Retail real estate is desperately trying to adapt with the departure of department stores and malls now renting to big box tenants. There are more restaurants, office users, and recreational activities in traditional retail spaces. Empty space is not necessarily piling up. There are many new retail successes among the growing wave of failures. It does not appear that the so called “retail apocalypse” by itself will crash the system.

Trade Wars

Reportedly, China is willing to resolve trade disputes with the U.S. A ceasefire on further tariffs is currently underway as agreements on trade issues are being negotiated. Though the trade war is a problem for U.S. exporters and it’s a red flag for the economy right now, I’m not too worried that the trade war will remain a growing problem that could lead us into recession.

Housing

Home sales are weak nationwide. In California, new housing is not keeping pace with commercial and industrial development. Consequently, California has predictably ended up with less new housing and sharply higher housing values. Higher home values are currently indicative of most robust regional economies in the nation.

And though higher housing values are making homeowners happy, they are slowing down the new and existing home sales markets, along with marginally rising mortgage rates.

The housing slowdown in and of itself won’t likely derail the economy, but it represents another sector that would weigh negatively on GDP growth and jobs in finance and real estate.

The Wealth Effect

The decline in stock market valuation has evaporated billions of dollars in household wealth. And through the wealth effect, consumer spending is interrupted by declines in asset values that represent household wealth. This includes home prices and stock prices. Declining values could overwhelm the positives that are now powering consumer spending and much of the economy, so the stock market is a key indicator for economists to watch closely.

If stock prices fall further in 2019, consumer spending could be meaningfully impacted and the risk of recession will certainly rise.

Foreign Trade

The fiscal stimulus in 2018 enabled U.S. companies to shake off signs of slower growth in China, Japan, Germany and elsewhere.

That stimulus won’t have the same impact in 2019. So investors worry about future growth, 2019 corporate earnings and 2019 profitability.

China is the third largest importer of U.S. goods and services representing over eight percent of all U.S. exports. Slowing Chinese growth is a drag on world GDP growth meaning a drag on U.S. GDP growth as well, due to less production of goods and services going to China. Lower growth rates for other countries exporting to China further slows our exports to those countries. This represents another potential crack.

Oil prices are sliding despite cuts in production by Saudi Arabia, one of the largest producers in the world. Why? Because everyone else is maximizing their production. Softer oil prices are good for consumers and the airlines, but bad for oil companies who employ thousands of workers worldwide. Falling oil prices won’t derail the economy but would likely produce energy sector layoffs and volatility in energy stock values.

Interest Rates

The Fed was poised to increase short term interest rates three more times in 2019, and perhaps a fourth time as well, pushing the federal funds rate to as high as 3.5 percent by the end of the year.

Higher rates reduce the demand for goods in interest rate sensitive sectors, such as housing and automobiles. They increase debt service levels and business credit costs in general, i.e., the cost of financing business operations and/or expansion plans.

But on January 30, the Fed issued a statement that surprisingly altered its course from one of normalizing interest rates to one of “patience” with interest rates as it evaluates the economy in 2019.

Economist Mark Zandi of economy.com predicted: “ . . . If the stock market fails to rally from here, it is possible there would be no [further] rate hikes in 2019. And, if stock prices fall measurably further, the slowing in growth could even force the Fed to ease monetary policy by the end of the year.”[1]

Even Fed chair Jerome Powell said himself, “The case for raising rates has decreased somewhat.”

A more dovish monetary policy stance along with inflation being a non-issue has led investors to buy both stocks and long term bonds, rallying the stock market over the last month and depressing longer term interest rate yields again.

Consequently, as of now, it does not appear that interest rates will lead to the possibility of a weaker economy in 2019.

Finally: Credit Spreads

Bond investors are now demanding high yields for the higher risk they perceive on government treasury bills or are selling short term paper to buy longer term notes.

The yield curve, as measured by the spread between short-dated yields and longer term bond yields, has steadily flattened towards “an inversion.”

An inverted yield curve has a pretty reliable reputation as a precursor to recession, Right now, the spread between the two is 27 basis points, the narrowest spread since August 2007.

This is a signal we can’t ignore because it’s been correct in predicting the last seven recessions.[2]

Even when it turns negative, the yield spread doesn’t signal immediate doom. Over the past 60 years, inversions have occurred anywhere from five to 17 months before the downturn in GDP growth. The average time period is 11 months.

Now, no one can predict a recession based on the inversion of the spread. Just predicting when the spread goes negative is a presumptive endeavor. But I’ve never been accused of avoiding presumptive behavior so here’s my guess:

At the current pace of a narrowing spread, it would turn negative as early as this summer and as late as March 2020. That would imply a recession as early as the second quarter of 2020 and as late as the first quarter of 2021. What would cause a recession sometime between mid 2020 and early 2021? We don’t know yet.

———-
[1] Mark Zandi, “2019 U.S. Outlook: From Virtuous to Vicious Cycle,”, Moody’s Economy.com commentary, January 2, 2019

[2] https://www.washingtonpost.com/news/wonk/wp/2018/06/28/people-are-worried-about-these-economic-warning-signs-they-can-relax-for-now/?utm_term=.9c2c8e718a46

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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What To Expect in 2019

by Mark Schniepp
January 2019

Growth Was Strong in 2018

Nothing much fazed the economy in 2018. The wild oscillations in the stock market, the trade war with China, the California fires, or the midterm elections. The economy remained strong all year long.

The fiscal stimulus in the form of tax cuts played out as the principal factor for the solid economy in 2018.

The California economy created 347,000 jobs last year, and the unemployment rate fell to the lowest level in 40 years.

We are now in month 114 of the economic expansion and bearing down on the previous record of 120 expanding months from March 1991 to March 2001. I have little doubt that the current expansion will soon be the longest on record.

The S&P closed down 6.2 percent for the year. But because everybody is working and incomes are rising, consumer confidence remained high despite a roller coaster stock market.

2019

Employment opportunities won’t be the same this year as last, not because of weaker demand for workers from employers, but because employers won’t be able to find workers to fill the increasing number of unfilled positions.

That means a slower year for output and the quarterly GDP reports, unless workers become a lot more productive.

Unfilled positions that need filling lead to higher wages and salaries. So expect to receive a raise this year or expect higher labor costs for your new employees and also your existing employees in order to preempt their taking another job.

The Fed will raise rates probably four more times in 2019.

We are looking at 3.5 percent on the fed funds rate a year from now. And if the 10 year Treasury Bond yield rises to 3.8 percent, the 30 year fixed rate mortgage will go to 5.4 percent by year’s end. Long term rates are not expected to rise as much as short term rates. This can be problematic because a convergence of the two frequently presages recession in 9 to 12 months.

The direction of real estate is more highly dependent on local factors. This includes job opportunities, housing supply, and relative prices. Homes will not be selling like hot cakes in 2019. There may even be a pull back as interest rates move higher, and less inventory (or low levels of inventory) limit the number of buyers that can afford to own housing.

The product being produced is largely apartments so more people will rent. If you own apartments, demand this year should keep them fully occupied.

The stock market is not predicted to collapse. But if there is a sustained decline in valuations, this would impact consumer confidence and consumer spending in 2019 and our expectations regarding interest rate hikes would change.

The trade war with China needs to end, but it’s likely to continue for a time longer this year. Global business sentiment has declined and exports from the U.S. farm sector have declined, which has impacted farmers. Given these effects which have grown more evident during the 2nd half of 2018, more tariff hikes are unlikely and there is a greater motivation from the White House and China to end the war.

Inflation will remain contained in 2019, at less than 3 percent. Gasoline prices are falling along with food costs and these should offset increases in wages and goods impacted by higher tariffs. Housing prices are expected to level off and won’t contribute to the inflation rate.

Summary: What to Expect in 2019

Jobs created: Fewer
Job opportunities: Very strong
Unemployment: Rock bottom
Average salaries: Rising
Trade war: Ending
Stock Market: ???
Interest Rates: Higher
Inflation: Same as last year
Housing: Weaker
Recession: Highly unlikely

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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Though Now Legal, Cannabis Sales (and Taxes) are Not Yet Meeting Expectations in California

by Mark Schniepp
December 2018

Licensing for Cultivation

California launched legal recreational marijuana sales and began licensing all other industry businesses including cultivation for the first time on January 1, 2018.

Permits for licensed cannabis cultivation have been issued throughout California over the last 11 months. To date, 5,871 outdoor and indoor permits have been issued and as of December 1, 2018, 3,432 are currently active.

It is the large scale cultivation operations that have emerged in California this year, acquiring dozens of licenses for smaller growing sites which they can combine into a single cultivation area. While there have been nearly 6,000 permits issued to grow cannabis, the total number of unique growers is only 1,830.

Each small cultivation license enables a growing space of up to 10,000 square feet. But a grower can obtain an unlimited number of these licenses.

This is especially true in Santa Barbara County, where more licenses have been issued than anywhere else in California, and the ratio of licenses to unique growers is 10.8 to 1.

Legal Participation in Cannabis Cultivation is Seriously Low

A recent study estimated the number of total growers in California at 68,150 in 2017.1 Consequently, if 1,830 unique growers have applied for and received cultivation licenses in 2018, this represents a statewide grower participation rate into the legal regulated market of just 2.7 percent.

In other words, the black market where most of the growers remain is seriously thriving despite the ability to become legal.

Tax Revenues in 2018

In January of this year, Governor Brown predicted annual tax revenues going to California at $643 million for the first year of legal cannabis production and retail sales. Taxes on cannabis pertain to both growing and retail sales of marijuana and derivative products.

However, during the first 3 quarters of 2018, total tax revenue collection has fallen short of expectations. At the current rate of tax receipts realized through September, it’s likely that just over half of the Governor’s tax revenue goal for calendar 2018 will be realized.

Why? The lack of grower participation to date is the biggest reason, along with a scarcity of recreational use cannabis shops in California. So far, there are 416 storefronts that have been licensed to sell cannabis and derivative products for recreational use in California. Thirty five percent of these are located in the greater Los Angeles metro area. The Coachella Valley is number 2 with 32 stores in Palm Springs, Cathedral City, and Desert Hot Springs. San Francisco is third but with much fewer outlets.

Along Interstate 5 between San Francisco and Los Angeles, adult-use shops are nearly nonexistent. There are no stores in Fresno, Kern, San Joaquin, San Luis Obispo, Placer or Nevada Counties. And there are only a few shops operating along the Central Coast of California.

In general, there are not enough establishments that are now open to conveniently serve the state’s population and generate tax revenues for the state. Why? Local prohibitions on adult use marijuana stores are a principal reason. You can only buy legal cannabis products in legally sanctioned retail outlets if they are permitted in your city or county. Even though Proposition 64 was approved in 2016 by about 57 percent of the state’s electorate, most cities in California still refuse to permit marijuana businesses. About 84 percent of cities in the state have banned adult-use retailers, whether storefront or deliveries. Right now, only 77 cities in California allow recreational sales of cannabis.

Prices

And then there is the price. Regulation and taxation is having a large impact on consumer prices. Though the wholesale price for leaf and flowers has fallen precipitously in the last year, prices for retail cannabis products in stores have not.

New packaging and testing regulations went into effect on July 1, 2018 and this has created confusion for regulated store owners, reduced product and increased prices.

And according to industry sources, the unlicensed (or black) market sells cannabis products for lower prices. In August, a marketing survey found that one in five Californians bought marijuana from black market sources and were “highly likely” to purchase again due to cheaper priced products, greater selection, and no tax.2

According to PriceOfWeed.com, this week’s average price per ounce for high quality marijuana is $256.63. For medium quality, the price drops to $207.13.3

The State of California has the second highest tax rate on cannabis growing and sales in the country, behind the State of Washington. Together with city and county taxes, the gross tax rate of cannabis products can go as high as 45 percent in California.

There was a proposal in the state legislature, Assembly Bill 3157, that would have lowered the state’s excise tax imposed on purchasers of cannabis from 15 percent to 11 percent for about three years. It also would have suspended the cultivation tax until June 1, 2021. But it did not have the support of Democrats and unions.

Last Word

The first year for the industry has been bumpy as the regulatory issues become institutionalized and applied. Combined tax rates on cultivated product and on retail sales are comparatively high and compliance standards onerous. For this reason, most California growers remain in the unregulated market.

More regulations on packaging, product uniformity and testing and fewer retail storefronts throughout California (due to local city and county bans) are pushing final product prices to the upside. Consumers are still seeking out less costly products and the black market is still thriving.

California cannabis industry conditions are evolving and it’s likely that the environment for growers and retail sellers will improve, together with tax revenue collections for the state and for municipalities. But currently, the regulated market is struggling with grower licensing, retail product shortages due to testing delays and distribution issues, and higher product prices (than the black market).  So as the first year of legal cannabis growing and sales sunsets on California, the industry is still in a state of flux.

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1 California Growers Association, “An Emerging Crisis: Barriers to Entry in California Cannabis,” February 19, 2018, page 6.

2 Investor’s Business Daily, https://www.investors.com/news/marijuana-stocks-california-cannabis-tax-revenue-q2/

Also see https://mjbizdaily.com/higher-prices-and-barer-shelves-california-cannabis-retailers-face-frustrated-customers/

3 For a sample size of 21,179 transactions. See the home page of http://www.priceofweed.com

 

The 2019 Edition of the New Development in California report will be available in late December, 2018. For more info, view our website here.

The report documents the principal residential and non-residential building projects in California. This is a must-have report for all construction and building material contractors, and anyone who needs to understand the new development environment in California.

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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What You Should Know About the Longest Expansion in Modern U.S. History

by Mark Schniepp
November 2018

1. The economic expansion is only 8 months away from becoming the longest on record

The record 1990 to 2000 expansion will be eclipsed in July 2019. That will put the current expansion at 121 months, or 10 years plus a month. It is likely that the expansion will continue throughout 2019 and into early 2020.

The bull market in stock prices set a new record for longevity. A total of 3,494 days from March 10, 2009 to October 3, 2018 eclipsed the previous record of 3,452 days during the 1990 to 2000 stock market run.

If the S&P index reaches another record high, the current pull-back represents a temporary pause and the long bull market would be extended.

2. GDP growth has accelerated this year, akin to a breakout

And this is unusual at this late stage of the expansion because the strongest surges of growth normally occur the recovery phase of the cycle. GDP growth jumped to 4.2 percent in the 2nd quarter and the initial estimate for the 3rd quarter is 3.5 percent. We estimate a 3.3 percent growth rate for the quarter that we are in now.

3. The economy’s labor force is fully employed

The nation’s unemployment rate of 3.7 percent is the lowest rate of unemployment since 1969.

If you want a job you can have one. There are 7 million job openings—18 percent more than a year ago—and more than there are people to fill them. Ironically, this is occurring at a technological time in which many entry level jobs have been eliminated by automation.

4. Wage and salary income growth remains mild despite extraordinarily low jobless rate

For the 12 months ending in September 2018, the average wage and salary income rose by 3.1% year-over-year. During the 12 months ending in October 2000, when the average unemployment rate dropped to 4%—as it did during the span ending in September 2018—wage and salary income soared by 4.2% annually.

5. However, adjusted for inflation and demographics, wages and salaries are rising nearly as fast as they did during the 1997-1999 expansion, a period often used for comparison

And in California, the growth of wages and salaries during 2018 is the highest in 18 years.

6. Inflation surprisingly remains contained

Despite rising wages, rising home prices, rising rents, and rising construction costs, the general price level has not increased much. There are higher rates of inflation in California but no runaway inflation.

7. Consumer confidence and consumer sentiment are at their highest levels since early 2000

U.S. consumers are still extremely optimistic about current economic conditions and future economic conditions. The index levels for October 2018 are some of the highest ever recorded in a series that began in 1967.

8. The U.S. manufacturing remains surprisingly strong

The ISM manufacturing index, which measures the expansion of manufacturing in the U.S., continues to show surprising strength. The August index rose to its highest level since 1984. September and October were slightly lower but still solid. Furthermore, over the last 15 months, more than 360,000 manufacturing jobs were created, the most for any 15 month period since the mid 1990s.

9. Interest rates are rising and surprising no one

There are no surprises because the Federal Reserve announced long ago their methodical plan to normalize monetary policy and so far, they have stuck firmly to it. Consequently, all federal funds rate increases have been anticipated by investors and this has enabled the financial markets to continue their record breaking journey despite rising rates over the last 2 years.

10. Home prices continue to soar

In tandem with the stock market, home prices have been rising continuously for the major part of the expansion. The median selling priced home in most major markets has now eclipsed its previous peak set during the housing bubble days of 2005-2006. This year, so far, home price appreciation in California remains quite strong despite all the claims that the housing market has softened and its days are numbered.

 

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The California Economic Forecast is an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.

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