by Mark Schniepp
January 2017

Happy New Year

The financial markets finished the year with double digit returns for calendar 2017 and the Dow Jones Industrial Average barely missed hitting the 20,000 mark on Tuesday, December 27. Currently (January 4^th), it is only about 32 points from its all time record high.

Bond prices appear to have stabilized for the moment, hovering around 2.5 percent for the 10 year Treasury and fixed mortgage rates are at 4.2 percent. The price of crude oil (and therefore gasoline) also appears stable at this writing.

We’ve reached the full employment level in the labor force, consumers are feeling very good today and about the coming year, and conditions for business expansion remain favorable. Depending on how fast the new Trump administration and Congress act, economic growth could attain its highest level of the current cycle in 2017.

Changes to Expect

The president elect will inherit an economy that is fundamentally strong. With very few layoffs and with record numbers of open job positions, it would take a severe shock to derail the current economy.

Significant changes in policy may be forthcoming, such as tax law, public spending on defense and homeland security, trade and immigration policy, and regulation.

We expect the Trump administration to implement an expansionary fiscal policy of deficit-financed tax cuts and greater government spending this year. So expect higher deficits.

The tax cuts will affect both corporations and households and are expected to be sizeable.

Higher stock prices are a clear plus for growth, through the wealth effect on consumer spending. Since the election and the run-up of stock prices, households holding stock are now worth about $1 trillion more. To the extent the market does not falter, that should produce more spending which will increase the rate of economic growth this year and next.

With bond rates rising, so are the myriad of interest rates. Higher rates of interest and inflation are in the base case scenario for 2017. That means that changes in these rates will not surprise the financial markets so no meltdown is expected.

The California Economy in 2017

You can expect an economy that looks much like it did in 2016 but with more jobs openings, more pressure to raise salaries and hourly rates of pay, and technology sectors that remain vibrant. This is because the world economy is growing faster again and there is rising demand for technology services and microprocessors.

Job creation is likely to be lower, simply because we are already running at full employment, so recruitment of workers will be difficult and more expensive.

The retail industry should have a banner year. Rates of retail real estate utilization are already low and sales remain moderate to strong depending on the region. With record levels of population, employment, and income, greater levels of spending on goods and services is inevitable.

The visitor industry is not expected to slow much despite the strengthening U.S. dollar. Some slowing has been noticed in a few areas of the State, including Santa Barbara. However, more domestic demand for California vacations will occur in 2017, and much of this will offset the reduction in foreign visitors who are now finding California (and the rest of the U.S.) too expensive.

If immigration laws are tightened and undocumented workers are deported, then the state’s agricultural, construction, and hospitality sectors will experience labor shortages. This will prompt higher wages and salaries and higher rates of inflation in California.

Technology industries are running strong and this is a principal reason that California has outpaced the nation in economic growth. Despite Trumpian rhetoric about bringing jobs back from the Pacific Rim to the U.S., there is likely to be more job creation abroad because tech companies cannot hire enough STEM educated workers here.

Housing will be impacted by higher rates throughout the U.S. but disproportionately in California. Why? Because higher mortgage rates drive monthly payments up by more on higher valued homes. And California has a higher share of higher valued homes than elsewhere. Also, less development of new housing in coastal areas will inhibit the growth of supply. If supply growth does not keep up with demand growth, prices rise. Coastal communities, including the Bay Area, are likely to experience fewer existing home sales in 2017 and higher selling prices.

Upcoming Forecast Conference:

2017 Entrepreneur Economic Forecast Conference
“Trumponomics, the Markets, and You”
February 2, 2017

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by Mark Schniepp,
December 2016

What’s moving upward?

• Expectations of growth in 2017
• The stock market
• Interest rates
• Inflation
• Consumer confidence
• The dollar

Why?

Irrational exuberance or eager anticipation of a rebounding U.S. economy unshackled from over-burdensome regulations, high corporate taxes and too-timid fiscal policy.

Trump and GOP congressional leaders share goals of cutting taxes and easing regulations, which would boost business investment. Most economists believe tax cuts, especially if not accompanied by spending reductions, would produce a short-term boost to economic growth.

Moreover, when and if it does occur, Trump’s proposals to increase infrastructure spending would lead to a surge in construction employment and income, and additional economic stimulus for all those sectors that support construction.

The forecast for growth

Economists marked up their growth forecasts for the U.S. economy as soon as Trump prevailed on November 9. The economy will expand between 2 and 3 percent in 2017—maybe even as high as 4 percent—and 2.5 percent in 2018.

The risk of recession in 2017 was already low, but it’s been reduced even further now.

Financial market rally

The market is celebrating the end of fiscal austerity. Equity investors have been betting that Donald Trump will live up to his campaign promises to boost government spending, cut taxes and lighten up on regulation. Since the election, all the major indices have been hitting record highs. The U.S. market rose last week recording very strong gains a full month after the election. The S&P 500 has soared 5.6 percent since November 8th. Financial and energy stocks have rallied sharply.

Interest rate spike

Rates are increasing because the economy is both doing better today and is expected to accelerate in 2017. The markets were already factoring in an increase in rates by the Federal Reserve Board before the election. Remember that long-term rates do not necessarily rise in reaction to the Federal Reserve moving short-term rates upward, but the expectation that the economy will accelerate in 2017 is readjusting the yield on 10 year U.S. Treasury bond, especially under a Trump presidency where higher growth is anticipated. Rates are still very low by historical standards – and they are not likely to move sharply higher in 2017. The forecast has rates rising to 2.8 percent in 2017 and 3.5 percent in 2018.

Run away inflation?

Year to date, inflation is averaging 1.1 percent nationwide and 1.9 percent in Southern California. The outlook for inflation was already higher for 2017 and 2018, despite which presidential candidate won. Full employment economies and long expansions typically produce strains on existing resources causing their prices to rise. With a greater fiscal stimulus proposed by Trump, the federal deficit is likely to rise and that is pushing interest rates, the dollar, and ultimately inflation even higher.

Recent forecasts have inflation moving to 2.4 percent in 2017 and between 2.7 and 3.3 percent in 2018. This would be the first stretch of sustained inflation above 2 percent since 2011-2012 but I’d hardly consider it runaway inflation.

A leap in consumer confidence

The Conference Board’s confidence reading for November was the highest in 9 1/2 years. The preliminary December report from the University of Michigan climbed sharply as well, rising to the highest level since December 2006. Consumers expect a positive impact of new economic policies following Donald Trump’s election. Furthermore, consumers feel more secure about the economy today and over the next 6 months then they have in years, largely because the labor market is at full employment, the stock market is at record highs, and incomes are rising.

The dollar gains against the Euro

The dollar has been rising sharply since Trump won the election on November 8, which triggered the meaningful sell-off in U.S. Treasuries in tandem with the soaring value of the dollar.

The speculation is that a Trump presidency will mean wider budget deficits and more inflation.

On December 9, the Euro fell to less than 1.06 in value against the dollar, the lowest level in 14 years. The dollar has rallied against most emerging market currencies and especially the Mexican peso, which has declined 52 percent in value (against our dollar) over the last two years.

The risk of a trade war between the U.S. and China and perhaps between the U.S. and Mexico is another reason for the advancing value of the dollar.

A rising federal deficit?

The deficit is the difference between the federal government’s total spending and total revenues each fiscal year. The annual deficit has been as high as $1.4 trillion in recent years, falling to $587 billion in the fiscal year (2016) that just ended. Trump’s proposed Keynesian policies are likely to widen the deficit in FY 2017 and sharply in FY 2018. While those yellow bars are only forecasts, if Trumponomics is realized, you can chalk up another indicator that is likely to rise sharply.

What does this all mean to you?

Higher Treasury bond rates will likely translate into higher mortgage rates and higher auto loan rates. However, because the stock market is at record levels, you should feel a lot wealthier. Furthermore, your disposable income is likely to rise with the election promise of lower taxes.

And because the unemployment rate is down to 4.6 percent, you are fully employed and your salary is rising anyway. This makes you feel much more secure about the future. That’s what rising consumer confidence is all about.

And as the dollar continues to strengthen, your summer vacation continues to get cheaper, especially if you’re going to South America, Mexico, Europe, and Malaysia.

So 2016 is ending up to be a great year and 2017 might be an even better one.

Upcoming Presentation:

Santa Barbara Rental Property Association
“A New Paradigm: With Trumponomics coming, what should you prepare for in 2017?”
January 19, 2017

by Mark Schniepp
November 2016

“In addition to causing noise, traffic and trash problems, neighbors say short-term rentals are detrimental to communities, because they reduce the supply of rental housing. Officials say they take away from hotel revenue.”^[1]

Cities across the country have begun to prohibit short-term housing rentals. Bans have now been passed in Santa Monica, Anaheim, Manhattan Beach, Redondo Beach, Hermosa Beach, and New York City. A complete ban also goes into effect in the city of Santa Barbara on January 1, 2017.

But to date, little research has been conducted on the necessity of these new laws. Are they justified in view of the myriad of allegations levied at short-term rentals, despite the absence of bona fide evidence?

The Issue

A common belief is that the proliferation of short-term rentals (rentals of less than 30 days), has lead to higher rents and home prices in many communities. When properties are rented through sites like AirBnB or HomeAway.com, they are no longer available to local residents, which limits housing options within communities.

This indictment of short-term rentals is especially heated across coastal California, where available housing is especially limited and therefore especially expensive. But are these claims accurate? Are short-term rentals really raising home prices and rental rates?

The Effect on Housing Supply

We recently completed a study to determine the effect of short-term rentals on the housing supply of Santa Barbara City and County. We surveyed 1,660 local STR owners, with a response rate of 20 percent and a margin for statistical error of plus or minus 3.6 percentage points.

One claim of STR critics was true – a large portion (87 percent) of STR owners rented out their entire homes. It was much less common for people to rent out a spare bedroom or a couch.

However, we did not find that the supply of housing was significantly affected by the incidence of short-term rentals in the City or County of Santa Barbara. This is because (1) compared to the total size of the housing stock, there are very few STRs in Santa Barbara City and County, and (2) very few of these homes are used as STRs full-time.

The second point is especially important. We found that many of these properties are vacation homes, beach houses, second homes, etc. The owners, their offspring, their extended families, or their friends use these houses for part of the year. Consequently, they would not likely be converted to long-term housing for local residents under an STR ban.

Overall, we found that an STR ban across Santa Barbara County would increase the housing supply for local residents by only 0.1%. With this finding, we are confident that an STR ban would not have a meaningful effect on housing prices and rental rates in Santa Barbara City or County.

We would expect this outcome to be indicative of many coastal communities in California, and elsewhere.

The Effect on Neighborhood Safety

It has also been claimed that STRs make neighborhoods more dangerous. The question of safety was originally raised in a report by the Los Angeles Alliance for a New Economy.^[2] In the report, the authors write about numerous complaints made to Neighborhood Councils about tourists staying in AirBnB rentals. “These complaints include unfamiliar cars blocking driveways, late night parties on formerly quiet streets, and concerns about child safety in an environment with fewer familiar eyes on the street.”

To address this issue, we collected and analyzed nuisance reports across communities in Santa Barbara County, as well as areas in San Luis Obispo County and Ventura County. We found no statistically significant difference between the nuisance complaint rate for STRs and all homes in cities where data were available.

In summary, the negative allegations aimed at STRs could not be substantiated by the statistical evidence. In the absence of proof, many city councils are making strict and firm decisions to ban STR activity based mostly on innuendo. And in doing so, they are willing to forego all of the revenue benefits associated with the regulated operation of STRs.

You can download our full reports on this subject from the sample research page of our website, here:

https://californiaforecast.com/samples-of-our-research/

We anticipate that STR bans will be proposed in more cities across the nation. Since we completed the Santa Barbara study, we have received requests for similar studies in San Luis Obispo County, Orange County, and as far away as New Orleans. Before taking action, we encourage all municipalities to objectively investigate the effect of STRs on their own communities.

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[1] The Daily Breeze, “Redondo Beach becomes latest South Bay city to crack down on short-term rentals, March 2, 2016, by Megan Barnes.

[2] AirBnB, rising rent, and the housing crisis in Los Angeles, http://www.laane.org/wpcontent/uploads/2015/03/AirBnB-Final.pdf

Upcoming Presentations:

Santa Barbara Executive Roundtable
Changes Ahead in 2017: Renewed Economic Vigor or Collapsing Into Recession…?

Thursday, November 10 , 2016
8:00 am – 10:00 am
University Club
1332 Santa Barbara St.
Santa Barbara, CA
Register Now

by Mark Schniepp
October 2016

Is the unemployment rate really full?

We are now at or within months of an economy at “full employment.” This means that (1) anyone wanting a job can obtain one, and (2) labor is tight and the general level of wages and salaries is rising as a result. Evaluation of the data on unemployment, help wanted indices, and wage increases shows that both of these criteria are now being met.

Is it really fair to use the term “full employment” when people are still experiencing difficulty finding work?

Unemployment is both regional and variant by age. The rate in Tulare County last month was nearly 10.7 percent. In San Mateo County, it was 3.2 percent. If you’re 19 and fresh out of high school, it’s going to be a lot tougher than if you’re 41 with 15 years of work experience.

Underemployment

A discouraged worker is a person of legal employment age who is not actively seeking employment or who has not found suitable employment after long-term unemployment. This is usually because an individual has given up looking or has had no success in finding a job, hence the term “discouraged.”

Often the conventional unemployment rate is criticized because it does not account for discouraged workers that have dropped out of the labor force and are therefore, not counted in the unemployment rate.

Often we are criticized for declaring that full employment has been reached in particular regional economies since people believe that there is still a significant level of “underemployment.”

Labor that falls under the underemployment classification includes those workers who are highly skilled but working in low paying jobs, workers who are highly skilled but working in low skill jobs and part-time workers who would prefer to be full time.

An alternative measure which seeks to explain underemployment is called the U6 unemployment rate. It expands the definition of the labor force to include “discouraged workers,” or people without jobs who have given up looking for work; “marginally attached workers,” or people without jobs who would like to work but have not sought employment recently, plus people employed part time (less than 35 hours/week) who would prefer to work full time.

Now, U-6 does not fully explain “underemployment” because there is no statistic that can quantify workers who are working in jobs below their perceived skill level. Therefore we don’t have a perfect measure for underemployment.

U-6 for August 2016 was 9.7 percent, or approximately twice the conventional unemployment rate of 4.9 percent. But U-6 has always been at a level that is approximately twice the conventional rate. Since 2008, the average difference between the two rates has been 6.2 percentage points. Today the difference is 4.8 percentage points.

The lowest reading for U-6 (since 1994 when the statistic started tracking) has been 6.8 percent in October of 2000.

While it is true that U-6 today is not quite back to the low level of 8.4 percent that prevailed prior to the Great Recession, neither is the conventional unemployment rate. Nevertheless, we are at or close to full employment and the U-6 rate today is consistent with historically low levels of that measure.

Who are the unemployed and the underemployed today?

The legal working age population ages 16 to 24 is the principal group that is either out of work or underemployed. The unemployment rate for this age group is currently 9.2 percent (versus 4.3 percent for the 25 to 54 year old age group).

Furthermore, this age group has very low rates of labor force participation compared to the 25 to 54 year old age group. Attending high school, colleges and universities is a large reason for the reduced rates of participation, but does not fully account for the collapse in rates over time. All groups are showing a decline in labor force participation over time, but the younger age group participation rates have tumbled, whereas the 25 to 54 year old group is off only 3 percentage points from the all time record high of 84.5 percent reached in August 1997.^[1]

Higher rates of unemployment and lower participation rates for 16 to 19 and 20 to 24 year olds is consistent with their lack of training, knowledge or skill in a modern technical and highly automated economy where these attributes have much higher value today than previously.

Moreover, labor force participation rates for the population aged 55 and over have been increasing for the past 24 years and are now at their highest levels since 1964. The older Baby Boom generation is educated, experienced, and skilled. They show very little sign of being discouraged in today’s economy, according to this statistic. Oh, and their unemployment rate in August was only 3.5 percent, the lowest of any age group.

Conclusion

Unemployment is low for most of the labor force aged 25 and above. And the rate of unemployment appears to be both full and absent any unusual degree of underemployment for this age group. Baby Boomers are not the discouraged workers in today’s economy.

The rate of unemployment and underemployment is substantially higher for 16 to 24 year olds. The implications of this strongly support the critical need for higher levels of education and/or training of this age group, today and going forward.

It’s not enough to simply attend a university today and obtain a Bachelor’s degree. The kind of degree that students seek will have a much bigger impact on their employability and their future earnings than it did for the Baby Boomers.

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^[1] The participation rate for 20 to 24 year olds was nearly 80 percent in August of 1989. Today, it has declined to 70.9 percent. The 16 to 19 rate fell from 57 percent to 36 percent over this same time period.

by Mark Schniepp
September 2016

Recession in 2017?

We are now more than seven years into the current economic expansion, having officially pulled out of the Great Recession in July of 2009. Consequently, the “up” phase of the current business cycle is getting old because they don’t typically last longer than 8 or 9 years. Yet if you google “recession in 2017” you’ll see a full page of articles predicting recession next year.

Pacific Coast Business Times, September 8, 2016, online

What do you think? Are we headed for a recession in 2017? I argue here that we won’t see a recession simply because we don’t deserve one, yet.

Why Don’t We Deserve a Recession?

We haven’t demanded any particular good or service into excessive oblivion. We don’t have technology stocks that are valued way out of whack (like in 2001), we don’t have bubble housing prices (like in 2006), and we don’t have major household debt (like in 2007). In fact, economic data regarding households or businesses is not out of balance.

 We have record vehicle sales because people are employed and have rising incomes, gas is cheap and is threatening to remain so, and many cars and trucks simply need replacement.

We have record stock market valuations because corporate profits have been strong, everyone’s working, inflation is contained, and the American economy is growing, relative to many of our global neighbors. The market is clearly not convinced that a recession is inevitable; otherwise stock prices would be eroding.

Homes are selling but at rates way below the bubble days. And this time, buyers can actually afford these homes, largely because interest rates are so low.

Home prices are rising and at unprecedented levels in some areas, like the Bay Area. But the underlying force to home demand in California is supply and demand, and not easy financing and/or a surge of new home development. Currently, for-sale housing inventory is very low (as is new home inventory), especially in the red hot Bay Area and that’s why home prices are 25 to 30 percent above the bubble peak!

The upward movement of GDP this year has been stunningly slow, and is now running at a 1.5 percent rate of growth (we were in the mid 2s in 2014 and 2015). U.S. growth has historically averaged over 3 percent, and about 2 percent per year since the economy started growing again in mid-2009.

The very poor GDP numbers this year have spooked many analysts into predicting a recession. But we don’t buy it. There are not many imbalances, no bubbles, and consumers are not stressed or overleveraged.

And it appears that the European economy is strengthening and China’s stock market is slowly recovering. So the world economy is, at the moment, not threatening to hinder U.S. growth for the foreseeable future. Not even Britain.

We don’t deserve a recession. We haven’t done anything wrong. So we’re not likely to get one. And therefore we don’t see much chance of recession next year.

________________________________________________________________________________

Our conference in Westlake last week was another big success. We hand many sponsors and a large crowd at our 39^th semi-annual event. Our next event is scheduled for February 2, 2017 at the Westlake Hyatt.

Plan to be at the largest and longest running economic forecast in Ventura County. And we do provide a forecast, a very thorough one, in our presentations and in our publications, for both Ventura County and Los Angeles County.

by Mark Schniepp
August 2016

The unemployment rate for the nation remains under 5.0 percent, and has essentially reached the “full employment” level. Wages are now rising on their own accord and not due to any government mandates.

GDP growth during the first half of the year has not been stellar, rising only 1.2 percent on an annualized basis. That’s a pretty poor estimate of overall growth in the U.S. economy. Yet, the economy continues to hum along with an unending record of monthly job creation, low rates of inflation, imperceptible interest rates, cheap energy, and record stock market values.

Oil prices are sinking again. Food prices were 1.3 percent lower in June 2016 than a year ago. The general inflation rate for the first 6 months of the year is 1.0 percent. In the Southern California region, it’s 1.8 percent. Higher inflation rates were originally forecast, due in large part to higher home prices and rents and slightly higher energy prices. And while we are observing higher rates of inflation in California, they are still relatively contained.

The interest rate story continues to be a dream for homeowners. The recent surge in refinance activity that we saw in June and July will produce more spendable income for households this year. Along with lower gasoline prices, consumers have more income to spend on stuff other than housing and fuel.

The U.S. dollar is strengthening again after weakening in March, April, and early May. The trend line in the value of the dollar against all other currencies has been rising since late May. Today there are nearly 19 pesos to the dollar. Last year at this time, the dollar exchanged for 15 pesos. Therefore, go to Mexico and drink tequila, cheaply.

In California, 40,000 jobs were created in June. The pace of new job formation for 2016 to date will result in more than 470,000 new jobs this year, which is a remarkable accomplishment at this stage in the economic expansion.

Since February 2015, monthly job openings have outnumbered hires as the availability of work opportunities has soared.

There will be no economic slowdown as we enter the fall season and the general presidential election. And though it’s always the economy stupid, it’s not so much this year because the economy remains solid with few soft spots.

The most favorable markets in the country for job seekers are those areas where job openings exceed the number of unemployed workers. As of July, the ratio of the unemployed to job openings was the lowest in the following major metro areas:

So, if you are looking for a job, move to one of these areas for the highest probability of finding the job you want. There are 5 months left in 2016. Make the most of them. Now is the time to refinance your home, take a vacation, change careers, or fill up your gas tank.

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Upcoming Event

Entrepreneur Economic Forecast Conference / Los Angeles and Ventura Counties
September 8, 2016
Westlake Hyatt
7:30 am to 10:45 am

Speaker topics will include:

How long can the current expansion last?
What about interest rates and inflation?
The 2016 El Nino fizzled; can we tolerate another year of drought?
What are the recession risks going into 2017?
Is Ventura County still lagging its peers?
Has commercial real estate peaked?

Event Info Register Now

by Ben Wright
July 2016

Many commentators have suggested that a British vote to leave the European Union would lead to global recession. They have drawn comparisons to the crisis in 2012 when large government deficits threatened to push Greece out of the EU. But Britain is not Greece for one important reason: Britain has its own currency.

Britain is not Greece

The Greek situation was dangerous because Greece uses the Euro, the currency it shares with 18 other nations. An exit from the EU would have forced it to abandon the Euro overnight and renegotiate its financial contracts, creating real problems for the banking system and threatening a replay of the crash of 2008.

But the United Kingdom uses the Great Britain Pound, one of the oldest currencies in the world, and no current geopolitical scenarios will alter this. The British national economy faces other issues, but the Pound will retain a prominent role in the global economy, and there is little risk that Brexit will mushroom into an international catastrophe.

The Short-Term Volatility is Over, But UK Growth Will Lag

In the minutes and days after the vote, stock markets tumbled around the world. Bond yields fell and the Dollar strengthened as investors rushed to safe haven assets. This was a predictable reaction to a burst of uncertainty, but the turmoil has now subsided and markets have calmed. The S&P 500 has reached a new high, and the index of British blue chips has surpassed its pre-Brexit value by more than 6 percent.

But the short-term effects were never the real danger, and new issues will unfold over the coming months and years. If English officials do not strike a new trade agreement in Brussels, their economy stands to lose substantial ground over the long term.

The UK is a large exporter of industrial machinery, aircraft, and other high-value goods. But so are Germany, France, Italy, Finland, and a number of other EU nations. Without a trade agreement, British goods would be subject to new tariffs, making them more expensive and less competitive in the global marketplace.

Over time, it’s likely that some of the UK’s trading partners would find new suppliers, which would slowly erode the manufacturing sector. Ironically, the industrial hubs that supported Brexit could be the biggest losers. It was developing nations like China and South Korea, not other European countries, that were their main source of competition.

Without free access to the European market, some firms would relocate to other parts of the EU, and others would delay investment into their UK operations. The most important may be the banking sector, which is arguably the preeminent hub of global finance. Some reports have estimated that London could lose 10,000 banking jobs over the coming years, relocating them to Frankfurt, Amsterdam, and other cities with existing financial infrastructure. Those first to leave may be at multinational firms that already have other EU offices.

Britain would almost certainly see lower levels of in-migration – their only current source of population growth. It’s very hard for an economy to grow without new additions to the workforce, and if migratory patterns reversed and the resident base began to decline, economic expansion would be considerably muted. Just look at what’s happening in Japan.

In total, economists estimate that the loss of trade, investment, and in-migration could reduce GDP growth by up to $260 billion over the next decade, and would place a drag on wages by upwards of 7 percent. UK households could lose $2,600 in annual purchasing power, and British exporters may lose 50 percent of their market share within the European Union. A recession is unlikely, but can’t be ruled out because the British economy was slated for slow growth even if the “Remain” campaign had prevailed.

Pain Will Be Concentrated In the UK

When growth slows in an economy as prominent as Great Britain – currently the 5^th largest in the world – it tends to influence conditions elsewhere. But the global effects of this scenario are expected to be mild.

Economists estimate that the U.S. would have grown by 2.5 percent over the next year, but have downgraded their forecasts to 2.0 percent, largely due to the drag from less favorable exchange rates. The Fed was ready to raise interest rates in July or September, but will now almost certainly wait until December or later, and international interest rates will remain lower than if Brexit had never occurred. US companies that have operations in the UK will reassess their options, and may lose some of their EU business.

The British economy stands to lose a substantial amount of trade, but some of this activity may simply shift to their EU competitors. Some of the migrants heading to London or Manchester will instead choose Paris or Munich. Barriers to trade are usually contractionary, but in this case there will be a meaningful substitution effect.

In general, outside of Her Majesty’s Kingdom, most of the world will take this situation in stride.

By Mark Schniepp
June 2016

Interest Rates

They were supposed to go higher in 2016—not sharply higher but noticeably higher nonetheless.

As you may recall, the Fed raised the federal funds and discount rates last December. This was the first such lift in rates since 2006. The conventional wisdom based on their remarks was that rates would be raised in a gradual fashion throughout 2016 and 2017.

But worries about the slowdown in China spooked the stock market at the beginning of the year and the Dow tumbled 1,900 points during the first 3 weeks of January. The U.S. manufacturing sector was sliding and durable goods orders were shaky. So the Fed held off raising rates in March. It’s now June and they meet on the 15^th. Another rate hike is now called for but wait, the employment report for May that just came out last Friday was a huge downer. Is that going to dash (postpone) another opportunity to push rates higher?

Perhaps…. or perhaps not. With the 10 year Treasury Bond yield falling to 1.64 percent on June 10, just a few days before the Fed meets, bond traders certainly don’t think the Fed will make another move. And one of the continued reasons cited is that as we get closer to the election this year, policy moves by the Fed will be interpreted as political, and I think they’d like to avoid that. But next week is far enough away from November and that’s why it’s a good option.

The Actual Rate Hike Itself Doesn’t Matter but Rates Need to be Raised

But it really doesn’t matter because another ¼ point hike in rates won’t impact much of anything. As the Fed has announced, a quarter point increase would be negligible but is a sensible first step to ensure the Fed stays ahead of inflation. Inflation remains on the radar screen and the Fed risks roiling world markets and pushing up the value of the dollar.

With the economy on the verge of full employment, there is growing evidence of wage and salary inflation, and that will translate into higher general price inflation than what we observe today.

With oil prices rising again, you probably are noticing slightly higher gasoline prices every week. There’s also a likelihood that your healthcare premiums will rise this year or next. And housing costs are clearly moving higher, for home buyers and for renters.

Higher expected inflation should push all market rates higher this year, unless those expectations are dashed because of offsets, such as a slower growing economy either here or abroad from our dominant trading partners.

Our forecast of inflation for 2016 is higher, and higher still in 2017. All the more reason why rate hikes are necessary, let alone warranted. The uncertain outlook for global growth should not stand in the way of the Fed resuming its path toward normalization of rates next week.

What is the Forecast for Rates Over the Next 18 Months?

Our forecast 18 months ago was for much higher rates today. But Europe got in the way, and then China. Now it’s the employment report, the presidential election, or whatever….

We are still sticking to a higher forecast of rates because the Fed wants to raise rates, the Fed needs to raise rates, and the market will push rates higher as inflation becomes more apparent.

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Upcoming Event

Entrepreneur Economic Forecast Conference / Los Angeles and Ventura Counties
September 8, 2016
Westlake Hyatt
7:30 am to 10:45 am

Speaker topics will include:

How long can the current expansion last?
What about interest rates and inflation?
The 2016 El Nino fizzled; can we tolerate another year of drought?
What are the recession risks going into 2017?
Is Ventura County still lagging its peers?
Has commercial real estate peaked?

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by Mark Schniepp
May 2016

Housing Market Update

Home prices continue to rise this year, especially in the California coastal markets. Home sales are running at a similar pace as last year—not too hot and not too cold.

There is less inventory everywhere, and this includes new housing along with existing. The average number of years sellers owned their home before selling jumped to 10 in 2015—the longest period ever recorded from an annual survey that began 30 years ago.

Low housing inventory is the biggest concern among California realtors, followed by housing affordability.

There are more home buying age people than ever before, and most of them are employed and their wages or salaries are finally rising. Consequently, the labor market is at peak condition to be generating home buyers.

I have addressed the Millennials many times in these monthly reports. But let me reiterate what we are seeing or not seeing regarding them and the housing market:

The percentage of first time home buyers has slipped to the lowest level since 1987 (28 years ago).

Home ownership for persons aged 35 and under is now at 34 percent, the lowest rate on record. Millennials clearly have decided that ownership housing is not yet for them.

And that’s because of the onerous student debt burden they carry, along with rising apartment rents which make saving for a down payment extremely difficult. And a larger downpayment is needed because housing values are at their highest levels since 2009.

Mortgage rates are still extremely low–like routinely under 4.0 percent for fixed rate loans—and more lenders are easing loan criteria.

However, these conditions are not necessarily producing a surge in demand for homes because the Millennial generation is not seeking ownership housing like past generations did at their age.

Consequently, if you suspect a housing market that is not quite as vibrant as you’d like it to be or as it might have been in recent years, that’s because there has been little improvement in the rate of sales, or the growth of inventory to sell.

Higher end properties are not being purchased as much this year as last. That may involve the stock market, which has moved upward since January 2016, but has made no net improvement over the last 12 months, or since May of 2015.

Is the Market at the Top Yet, for this Economic Cycle?

I don’t believe there has been any top in the real estate market yet. At least not regarding transactions. Home prices should continue to move higher, albeit at a slower pace than what we’ve observed since 2012. Low inventory because homeowners are not selling, and low demand from the Millennial generation make this real estate market very different from past ones.

It appears that for the short term, more of the same is the most likely direction for the housing market.

And though we said no recession this year…… we still mean it

by Mark Schniepp
April 2016

2016 Recession Update

I’m reading a lot about economic recession lately. A recession that is seemingly looming and could strike the nation THIS year. It’s become a popular internet topic in view of the Chinese stock market collapse, the negative interest rates in Europe and Japan, the UK wanting out of the European Union, and the recent slowdown in U.S. corporate profits and retail sales. We know that first quarter GDP has struggled to remain positive.

The Stock Market is Grinding its Way Back

But I’m not ready to switch to the dark side yet. Yes, there was a disturbance in the force earlier this year with our own stock market falling 1,000 points in the first two weeks of January. But all of the financial indices have been working their way back to their highest levels before the January meltdown.

The S&P 500 index is only 75 points (or 3.5 percent) from it’s all time record high.

Car Buying Still Remains Impressive

Americans are buying more cars at a near record pace. There are more vehicles on the road than ever before and traffic remains tough. The seasonally adjusted annualized pace of 17.5 million units in February was the strongest in 15 years. All the gains over the past year have been in the light truck segment thanks to persistently low gasoline prices.

New Home Sales are Clawing Their Way Upward

New-home supply reached its highest level since late 2009 in February but remains tighter than historical standards. Furthermore, the inventory-to-sales ratio held steady at 5.6 months but is still up nearly 25% over the year. This is nationwide inventory. It’s only 3.5 months in California and not generally rising.

Despite the past several months of decline, the NAHB Housing Market Index is near its highest level since 2006 and indicates that homebuilders feel confident about future construction activity. Sure enough, housing starts increased 5.2 percent between January and February and are 31% higher than in February 2015.

The Labor Market Continues to Improve at a Steady Pace

Job creation exceeded 200,000 again in March, the 6^th consecutive month that gains were above that threshold. The pace is sufficient to tighten the labor market. Consequently, worker recruitment is becoming much more difficult and average hourly earnings are rising faster. The unemployment rate is 5.0 percent.

Employment growth is clocking in at a healthy pace, and wage growth has started to accelerate, providing more incentive to potential homebuyers still waiting on the sidelines. In addition, despite expected tighter monetary policy over the next few years, mortgage rates remain at rock bottom, and this should encourage greater housing demand over time.

Manufacturing Rising Again

It seems that the U.S. industrial sector is showing clearer signs of a rebound. The manufacturing index, which has largely been in decline since last July, posted two consecutive months of expansion in February and March of this year. New orders for goods rose sharply in March, recording the largest monthly gain since 2009.

No Recession

We are just about at the 7 year anniversary of the end of the Great Recession. By mid-summer we will be in the 8^th year of an economic recovery/expansion. And while the up part of the business cycle does not normally last more than 8 or 9 years, we might actually be able to extend growth out for an indefinite period. After all, the first 3 or 4 years of the economic recovery were so weak that few people were convinced that the recession had ended. So one might argue that we are “owed” a few more years of positive economic growth.

A higher stock market leads to more spending by consumers because of the wealth effect. Retail sales, which have been dragged lower in recent months by falling gasoline prices, should move higher going forward, especially as the U.S. economy approaches full employment and average earnings move higher.

While the risk of recession has increased from 15 percent in March of 2015 to 21 percent in February of 2016, that’s still a relatively low probability that the U.S. economy will fall into recession in six months.

So plan accordingly for another year of growth. Plan also for slightly higher interest rates, inflation, and difficulty hiring more workers. Barring a calamitous event, the demand for your product or service should not be impacted much by the general economic mood in 2016, except perhaps to the upside.

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