Category: Uncategorized

by Mark Schniepp
September 2018

The Seasons Are Changing

It’s fall. School started again. My kids began their junior year in high school. Though they didn’t say anything about it and would certainly never admit it, I think they were glad at the change in their daily schedules that 6 hours of school brings. After all, school also brings their friends together, sports, and social events.

And parents’ schedules often change to accommodate school. You have to drive kids to school, to sports, and to the events. You have to make time to attend some of the school functions. You might even be asked to solve a homework problem or two, or help with a school project.

It’s getting darker in the morning, so I have to turn the lights on when I get up. I also have to shut the windows (halfway) because I’m noticing falling temperatures in the early morning hours and slightly cooler days. My cilantro was bolting like crazy in July, but now I can grow it again. There is change with seasons.

And what about the economy? Though some subtle changes are occurring, for the most part, there’s a lot less change than what’s happening with school starting, temperatures falling, fewer hours of sunlight, and my cilantro garden.

Tariffs Are Here

They represent a change, but how big a change?

Following the round of tariffs in the spring, another wave of tariffs was implemented last week, this time on $16 billion worth of Chinese goods imports. China has retaliated in kind, with 25 percent tariff rates on $16 billion worth of U.S. goods imports, targeting chemical and fossil fuel industries.

The latest wave of tariffs has imposed duties on $100 billion worth of goods imports. However, this represents only about 4 percent of total imports, so it’s not that significant of a change.

Some protected industries may benefit from higher tariffs on foreign competitors, but businesses that rely on foreign imports, such as retailers and finished goods manufacturers, will face higher input costs, and U.S. consumers will face higher prices. Protectionist trade policies have also resulted in retaliation by some principal trade partners but the extent of that retaliation has not been very significant.

Though we haven’t seen much yet, trade-related uncertainty is likely to weigh on business confidence and investment, while an escalation of tariff activity has the potential to slow down consumer spending if import prices rise. However, recent negotiations with Mexico over NAFTA, which have resulted in a new agreement, and the resumption of talks with China could signal an appeasement of tensions in coming months.

To reiterate, there is little to any indication that new tariffs have impacted the economy. Manufacturing continues to grow, exceeding expectations, as is consumer spending, and the value of exports is still rising together with imports.

Inflation and Interest Rates

Both are rising, but gradually.

A tighter labor market, stronger wage growth and the tax cuts have provided a big boost to spending, especially at restaurants and clothing stores. Retail sales growth has surged over the last several months, and consumers continue to be a strong engine of growth for the economy.

The acceleration in spending together with a fully employed economy incentivizes the Fed to continue normalizing interest rates, and this month rates will go up again, likely by another quarter point.

GDP Growth

Above trend performance.

Second quarter 2018 growth was revised upward to 4.2 percent, and third quarter GDP is tracking at between 3.5 and 4.0 percent growth. These values are a change to the upside and represent some of the fastest growth observed during the current expansion.

The economy keeps firing on all cylinders domestically and the implications for GDP growth are positive. The consensus forecast has the economy on track for above-trend performance this year and during the first quarter of 2019.

What’s Not Changing?

Fed interest rate policy. The Fed was expected to raise rates gradually in 2016, 2017 and 2018 and that’s exactly what has happened. Investors have not been ambushed and are pleased with predictable interest rate conditions. Consequently, long interest rates have only moved slightly higher over the last 18 months, the stock market is moving upward again, and there has been no slowing impact on growth.

General economic conditions. Basically, the economy hasn’t changed much, despite entering into the 10^th year of the current expansion in July. Another 10 months and the 2009-2019 economic expansion will be the longest in recorded history. By now, economists thought a slowdown would have occurred along with a faster pace of inflation, higher treasury bond yields, a stock market correction, and a hiccup in international trade flows. None of this is here yet.

Both consumers and businesses still feel very good about today’s economy. And they should be with the value of output rising, wages and salaries rising, the stock market near all time highs, and labor markets fully utilized. Furthermore, the likelihood of recession remains very low and is, in fact, declining again.

Now is not the time to worry yet. Enjoy the fall.

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by Mark Schniepp
August 2018

Three Come to my Attention

1. Workers
2. Housing, and
3. Water

In fact, we have escalated the “housing shortage” into a “housing crisis.” Soon, and we might already be there, we will have a “worker” crisis. Despite the end to the drought in Northern California, we still refer to the issue of water as the water shortage here in Southern California.

Why Do We Call it a Shortage?

In the case of workers, the unemployment rate has declined to 3.9 percent nation-wide, and 4.2 percent in California, both at their lowest levels in a generation or more. In Los Angeles, the unemployment rate has now fallen to the lowest level in 50 years. Workers are tough to recruit, both skilled and unskilled. Often times employers have to offer a lot more pay for the same position or accept lower or un-skilled candidates for that job, or both.

In the case of housing, the current pace of demand is faster than the pace of supply, and this is causing ever increasing prices for rental and purchase housing. Inventory levels of for-sale housing are at 10 year lows. Apartment vacancy rates are extremely tight everywhere you go and in many areas are at record lows.

In the case of water, water purveyors and cities have called for extreme conservation measures to reduce water use. No lawn watering during the day (or at all), shorter shower times, low flow faucets, elimination of gardens, etc. Many municipalities have increased water rates to pay for higher cost water systems or to finance water banking or storage.

Is it Really a Shortage?

No.

In a capitalistic and competitive economy, there are no shortages. Markets “clear,” meaning that the price is the allocating factor when there “appears” to be a shortage. People generally proclaim a shortage when the price rises sharply or beyond traditional or affordable levels.

A true shortage would occur if the price was fixed and demand was greater than supply. Then people who wanted the good would only be able to get it by some other allocation method other than price, such as by lottery or having to wait in a queue for more of the good once it was produced. Price would not be an allocating factor but you standing in line would be. Or you successfully bribing the distributor of the good to provide it to you for an amount above the fixed price.

So a shortage only occurs when you cannot obtain the good or service when you need it or want it (and you are willing to legitimately pay more for it), allowing perhaps for some transitional time for errors in inventory or delivery lags or whatever.

If it’s not a Shortage, Then What is It?

It’s called market clearing: the forces of supply and demand and the end result: price appreciation. That is how capitalistic economies allocate scarce resources. Right now, housing is scarce in California, labor is scarce all over the nation, and water is particularly scarce in Southern California.

How do we eliminate scarcity? We allow the price to rise and allocate goods through the price system. If you have $1 million, you really don’t face a housing shortage. You can buy a home in most markets of the state for that amount, except perhaps the Bay Area, Santa Barbara and particular areas of Orange and Los Angeles Counties. But in general, a million dollars will buy you a house with little delay, today.

If you need to fill a position in your office, you can probably get it filled right away if you are willing to offer a higher salary than your competitors, more benefits, or both. There will likely be no shortage of candidates for the job.

If your budget does not allow for offering more salary or for spending more for housing, then you need a Plan B. Having to accept Plan B has you thinking “shortage,” because as we all know, Plan B is seldom preferable to Plan A and may test your maximum willingness to pay.

What Can We do About “Shortages?”

Or what can we do about demand becoming excessively greater than supply and prices rising sharply beyond our affordability levels?

Produce more of the good, which is the response of supply to excessive demand. In the case of housing, we probably can’t do that in California because of so many constraints including land, CEQA, nimbyism, and policies (or laws) that restrict building, density or both.

So we are left with high prices and rents for housing and it’s likely to stay that way unless the growth of demand slows down, stops, or reverses. This might happen during the next recession like it did during the last one.

“Labor shortages” are always cyclical and are therefore always temporary. The “shortage” of workers will end when the economy slows down or contracts, or technological advancements are able to substitute many robotic or automated processes for human driven activities today. This may happen sooner than you think and we may be talking about a surplus of labor instead of shortages.

And in the case of water…. well that’s easy. A decent rainy and snowy year or two will dash any drought and enable us to water our lawns again.

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by Mark Schniepp
July 2018

Is the Student Loan Debacle a Bubble, and will it Burst?

In a word, and despite what Mark Cuban says: No.

However, student loan debt is still a problem due entirely to its enormity. It’s already having an impact on the economy, and this will continue for many years to come.

Why it’s a Problem

This particular debt issue is not a repeat of the financial crisis of 2007 that occurred when the housing bubble exploded. Student loan debt is not really a bubble that will pop. It’s more akin to a balloon that will slowly leak.

Most of the debt is carried by Millennials, who were born between 1980 and 2000 and are now roughly 18 to 39 years old. They are now the largest generation in the nation and represent the largest age cohort in the workforce today. Student loan debt is the largest debt load they carry and it will persist for many years hence.¹

Debt is hampering overall spending by Millennials in the economy. This is especially evident for the existing housing market and the consumption that goes with it. There is decidedly less home buying during this economic expansion, and that means less homeownership. With lower homeownership, there is less spending on furniture, fixtures, and furnishings. There is less home building, and fewer architectural, engineering and construction services needed.

And other expenditures are being replaced by debt repayment, which produces less economic stimulus than expenditure on private sector goods and services.

Since you can’t get rid of these loans via bankruptcy (like you could with any other debt) borrowers are on the hook for them until they are ultimately paid. The only way borrowers can avert the debt is to flee the country or die.

Default is more likely to have a slow motion impact, in line with the notion of a leaky balloon.

Why there’s no Bubble

Most of the debt will be repaid over time, and both banks and the federal government could well make a profit from these loans. But if delinquency and default rates continue to rise, then the public sector loses.

Federal student loans constitute 85 percent of all outstanding student loans, and most of these loans are backed by guarantee, which means that banks making these loans through 2010 are not on the hook for payment default.² The federal government is. Back in 2008 when the housing bubble popped, it was the financial institutions that took the loss. This time, it will be the federal government. We don’t expect to see a financial crisis spreading through the private financial sector.

But who really loses? You do. It’s your loss, the taxpayer, since you provide the government with most of its revenues for running government programs like federally insured student loans.

Bubbles burst when asset pricing in markets does not make sense. So a correction occurs. But the price mechanism that corrects does not exist for loans held or guaranteed by the federal government. So what happens?

Consequences Ahead

Taxpayers will be on the hook for providing the federal government with increased revenues to offset the losses. We already have large federal deficits and they are rising. This will only increase the size of the deficit until the public pays for it through taxation.

Education costs will be driven higher as students obtain loans and inundate colleges and universities. This notion was advanced by former Education Secretary William Bennett and is known as the Bennett Hypothesis. Students have relatively easy access to uncollateralized loans and this has led higher educational institutions to raise prices (increase tuition). Consequently, federal student aid has not necessarily made higher education more accessible or more affordable. The resulting education may ultimately not return an income stream that justifies the cost of that education. When this happens, the demand for education will decline.

Colleges and universities that did not contain their costs might become insolvent.

The federal government will continue to change its policies regarding student loans. Right now, it does offer loans to students that need assistance. Everyone else must obtain loans from private institutions. And interest rates on these loans are not always designed to hedge the overall risk factors that could lead to delinquency and default. There will be changes in how we finance higher education.

Look for student loan caps, higher interest rates, and the removal of loan forgiveness options for any borrower.

Finally, we might already be seeing a shift in Generation Z, currently the youngest generation who are just now entering 4 year colleges and universities. They appear to be much more calculating when it comes to higher education and are more apt to factor in college affordability and community college than Millennials were.

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¹ The standard repayment plan for federal student loans puts borrowers on a 10-year track to pay off their debt, but the average bachelor’s degree holder now takes 21 years to pay off his or her loans. Under federal income-based repayment options, remaining debt is forgiven after 20 years.

² Under the guaranteed student loan program, private lenders including Sallie Mae and commercial banks issued student loans that were guaranteed by the federal government. The program ended by Congressional mandate on June 30, 2010. Loans made since that date no longer have a government guarantee (unless they are direct government loans, or FFEL). Loans that default by student borrowers are taken over by the federal government and a contracting “guarantee agency” then services the loan. Banks are paid off by the guarantee agency and the latter attempts to collect on the loan.

by Mark Schniepp
June 2018

Student Loan Debt has Soared

With over $1.5 trillion in loans outstanding, student debt is now the second-largest source of household debt (after mortgage debt) and is the only form of consumer debt that continued to grow during the aftermath of the Great Recession.

The principal concern over the last few years has been the shear volume of student loan debt and the speed at which it is rising over time.

Per graduating student, debt loads are non trivial, and are now at their highest levels ever measured. The average student loan burden for Class of 2017 graduates was $39,400, up 6 percent from the previous year. More than 44 million Americans today carry some student loan debt.

Tuition costs have soared at colleges and universities. Between 1997 and 2017, in-state tuition at public universities jumped nearly 240 percent. During this same period, consumer price inflation increased 53 percent. Consequently, the cost of college and university tuition outpaced the general price level by 5 times.

And relative to expected income, tuition has increased to between 25 and 40 percent of an adult’s median household income. Back in 1970, annual tuition represented between 7 and 20 percent of the annual median household income. The result is that student graduates owe a far greater amount today relative to their current and future incomes than the baby boomer generation who graduated from colleges in the 1970s and 1980s.

Student loan payments average $351 per month for those who carry debt. If your starting salary after graduating from a 4 year university is $60,000 per year, those debt payments represent 9 percent of your monthly take-home income. Clearly, graduates earning less have a higher loan payback percentage of income, and this diverts household spending from private sector goods and services to federal loan repayment, an area of expenditure with a much lower, if any, economic multiplier.

Interest rates on new student loans currently range from 5.05 to 7.6 percent.¹ This makes student loans more expensive than paying a mortgage. And this is especially true for graduate students (and parents) who face the highest rates from Sallie Mae. Freshly minted lawyers and doctors can have student loan debt of $200,000 to $500,000, which is often larger than a mortgage.

National University Rankings by Cost of Annual Tuition

The size of student loan debt and its growth over time has previously been the focus of attention, but now a growing concern is the default rate among borrowers.

Delinquency

New data show that delinquency rates on student loans may be going as high as 40 percent of borrowers by the year 2023. The default rate is already higher than anticipated for the particular student cohorts studied, so the federal government should be bracing for substantial non payment of debt.

Currently 58.5 percent of all direct student loans are in repayment, and 41.5 percent are not. Regarding those that are not, 23 percent are in deferment or forbearance, meaning the repayment is temporarily suspended with or without interest, on the request of the borrower. Five percent are still in the grace period and 15 percent are in default.

When a borrower defaults, he or she simply fails to pay interest or principal on a loan when due. So if the loan is federally insured, as most loans were up to mid-2010, then the Federal Government is on the hook. It’s the same thing as when the U.S. loans a few billion dollars to the Cayman Islands and they don’t pay it back. In fact, as of 2017, the Caymans owed the U.S. $302 billion. Canada owes the U.S. $380 billion. Neither of these countries is likely to default however, but countries have in the past like Mexico in 1994 and Argentina in 2001. And we can’t trace these defaults to an impact on our economy.

Can students merely declare bankruptcy to avert paying back the loan? No. Student loan debt is virtually inescapable and is precluded from debts that are dischargeable in the U.S. bankruptcy code.

Consequently, there are increasing stories online reporting how debt strapped former students are fleeing the country and hiding out from Sallie Mae and collection agencies.

Sallie Mae is the nation’s largest originator of federally insured student loans. It was formerly a GSE, but it is now entirely independent from the federal government.²

Is the Potential Flood of Defaulting Student Loans Another Looming Financial Crisis?

1. First, the Basics

Our lending systems generally work efficiently and borrowers don’t default on debt because lenders won’t make too many high risk loans. System risk rises when lenders extend unwarranted credit. This occurred during the housing bubble days of 2004-2007 when easy credit gave rise to massive home buying pushing selling values to record levels.

A bubble “pops” when prices correct to more accurately represent the intrinsic value of the asset. Clearly, home prices towards and at the peak exceeded the true value of those homes. Prices corrected, borrowers owed more than the home was worth, and there were unprecedented numbers of defaults and lender bankruptcies. Loans ultimately became restricted and this slowed down the economy because businesses had difficulty obtaining capital needed to grow, invest, and hire.

2. Student Loans

Is the current student loan debacle a bubble? And if so, when will it burst?

I’ll address this in the upcoming July newsletter.

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¹ https://www.credible.com/blog/refinance-student-loans/what-are-average-student-loan-interest-rates/

² A GSE is a government-sponsored enterprise, or a financial services corporation created by Congress to enhance the flow of credit to particular economic activities such as agriculture, home finance, and education.

by Mark Schniepp
May 2018

No Suprises

The employment report for April produced no surprises. Job gains remain relatively strong, the unemployment rate continues to tighten, and wage growth is ahead of inflation. It is curious that wages and salaries are not rising faster given the tightness of the labor market. This is disappointing for workers but it will keep the Fed on track for three rate hikes this year because inflation remains predictably in check. It’s likely that stock market volatility will also subside, at least for the meantime.

Why the Probability of Recession is So Low

The probability of recession rose in March but still remains low. The odds of a recession this year should be low because recessions occur when imbalances develop in the economy, and no glaring potential macroeconomic imbalances are forming.

The labor markets continue to create more jobs, and the financial markets, while exhibiting more volatility since January, still remain buoyant. A fully employed economy, rising housing values, improved access to credit, and low household debt are driving both the consumer and business investment engines of economic growth.

Consumer confidence remains near its highest level in a generation. The present economic climate is rated consistently more favorably while economic expectations remain strong.

Consumer confidence at these stratospheric levels is consistent with a fully employed economy, households with rising real wealth and low debt, and low inflation.

Further tightening in the labor markets is likely this year, even as the pace of job growth continues to moderate. Employment growth has gradually declined toward 150,000 jobs a month in the U.S. and 20,000 jobs per month in California. This moderation is expected to continue through the rest of 2018.

A decrease in job growth is not abnormal at this stage of the business cycle and should not be mistaken for an economic slowdown. However, as long as job creation continues to exceed the flow of entrants to the labor market (80,000 to 100,000 a month), the unemployment rate is very likely to fall to 3.5 this year. Currently, the rate is at 3.9 percent.

Slower population growth and aging of the population will continue to exert downward pressure on labor force participation rates which will restrain labor force growth.

Growth in the economy in 2018 and 2019 will have to be accommodated with fewer additions to the workforce, due to slow growth in the labor force and a labor market that has very little slack. Consequently, look for much greater investment in automating business processes and functions. This has been the subject of my March and April newsletters.¹

The environment in California is even more austere regarding labor market capacity. The unemployment rate has now reached a level that it has not achieved since the late 1960s. And predictably, wages have been rising more sharply here than in the rest of the nation over the last 18 months.

This year employee compensation is forecast to rise 4.0 percent compared to a 2 percent increase in 2017.² Average salaries are forecast to rise 3.0 percent in California this year, after relatively hefty gains of more than 3.0 percent in the Bay Area economy during 2017.

The Updated Forecast

Even though the stock market has been under pressure since January (largely because of rising interest rates), the rest of the economy has remained more steady. This includes consumer spending, business investment, manufacturing, and surprisingly, inflation.

I believe that economists are much more focused on inflation than previously, because the labor markets should be producing faster wage growth now.

We are watching for any unexpected movements in inflation because that would pose one of the bigger risks to interest rates and the economy this year.

That said, nothing seriously out of the ordinary is within view. At our vantage point right now, it appears that the economic indicators for 2018 will remain auspicious.

The consensus forecast has real GDP still on track to expand at a pace of close to 3.0 percent this year with a slowdown strongly projected for 2019 and 2020.

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¹ For all of the monthly newsletters of the California Economic Forecast for the 2018 calendar year, please go here: https://californiaforecast.com/monthly-newsletter/

² UCLA Anderson Forecast for the State and Nation, March 2018, page Nation-15.

by Mark Schniepp
April 2018

In this part 2 of my monthly newsletter blog on robots, I’ll mention how our fully employed economy is rapidly accelerating investment in and implementation of a robot workforce.

Are We Actually Experiencing an AI Explosion?

The world of artificial intelligence is advancing so rapidly and in so many industries, countries, and applications, that to many it feels like the automated evolution is rising exponentially. Here is tech writer Tim Urban’s (waitbutwhy.com) illustration of just where we are on the timeline of human progress and the explosion that is allegedly right in front of us.

There is this notion that rapid growth in AI (or rather, explosive exponential growth) is here now or just in front of us. Tom Friedman’s best selling book, Thank You for Being Late, also supports this premise.

However, I don’t believe we are this far along the S-cure of progress, because implementation of robotic technologies is not evolving at light speed. AI trends such as virtual assistants, smart robots, and human voice adapting are still in their relative infancy and taking more time than initially thought to be really useful. While I think the future is soon, it’s not that soon.

Consequently there is time to prepare your company and your workforce for the robot economy. And it’s a good idea to start soon because there is no doubt that the robots are coming.

In last month’s newsletter I mentioned a couple of AI applications fully operational now. Aside from Flippy at Caliburger in Pasadena, there are many examples just in the past 18 months of robots successfully performing repetitive or mundane tasks in a variety of industries.

Robots are quickly expanding in the food industry mostly in China and Japan, but also here in California. The robot restaurants in China have replaced greeters, waiters and some cooks. They are growing more popular, even if only as a curiosity for visitors to experience being served by robot waiters.

For a number of years robots have largely worked in industrial capacities, bolted to an assembly line. Industrial robots are automated, programmable and capable of welding, painting, product inspection and testing, all with precision, consistency and speed. A study by MIT economists found that robots were responsible for the loss of up to 670,000 manufacturing jobs between 1990 and 2007 in the U.S.

Amazon and Walmart employ hundreds of thousands of machines within their warehouses and fulfillment centers that do much of the heavy lifting of goods, and filling and organizing shelves with the help of directing human workers.

The warehouse robots have replaced some humans and the growth of Amazon has created thousands of new human labor positions, but the massive growth of e-commerce including the numbers of new warehouse hires do not mitigate the overall retail jobs losses that have been the consequence of this growth.

Sea Change in the Use of Robots?

Now, a new generation of robots is here, capable of moving among people and therefore finding a wider range of work in stores, hospitals, hotels, and offices. And this has become a major cause of concern because the McKinsey Global Institute reported that 30 percent of the global workforce could be displaced by robots by 2030.

While robots employed now are not displacing too many workers, they will in the future as they become more dexterous and smarter, and as human workers performing repetitive tasks become too expensive. Robots don’t need to be paid the minimum wage (or any wage at all) and they don’t need healthcare, family leave, sick leave, “a change in perspective,” vacations, or worker’s compensation insurance.

There would likely not be massive unemployment because millions of new jobs would ultimately be created. Robots need repairmen, software programmers, circuit board designers, ergonomic specialists, etc. Consequently, robots do pose a disruptive force that will push us to seriously reevaluate our occupational training and skill set more carefully than ever.

This is a good thing because when human jobs are eliminated much of this can take place mainly through attrition, particularly as the baby boomer industry continues to progress into retirement.

Wages are now rising more rapidly in the fully employed economy, and this trend is likely to reverse as automation increases. Consequently, it is more important than ever before in human history to own skills that are deemed necessary for a rapidly evolving techno-economy.

Furthermore, companies must adopt coming trends in AI that can create competitive advantage and generate value. This is what Amazon has successfully done, (and not without major criticism for being one of the early and successful pioneers).

At a minimum, you can at least own assets that will rise in value as a result of AI growth. To me, this means owning shares of companies like IRobot, Nvidia, Google, Bosch, Ekso Bionics, Northrop Grumman, Honda, Boston Dynamics or Waymo. There are many others so now is a good time to conduct your own research.

by Mark Schniepp
March 2018

We’ve been reporting for years that the labor markets in California and the nation are as healthy as they can possibly get, that anyone who wants a job can get one, and that technology has been the engine of growth during this expansion.

The state just revised the jobs numbers for 2016 and 2017 that affirm all of this, and then some.

The unemployment rate in California is the lowest since reliable records have been kept. My data for the state go back 50 years to 1968.

Technology employment, though slowing down, is still the engine of growth in California and remains the fastest growing sector of the Bay Area economy.

California created another 333,000 jobs in 2017, about 40,000 more than previously reported. My continued question about this is how can the state and its regions continue to produce more jobs when the unemployment rate says that the labor force is fully employed?

The only way to create new jobs is for the labor force to expand. Now the labor force is merely the population, 16 years or older, that wants to and is able to work. The labor force expands when seniors graduate from high school or college and enter the job market, and when graduates complete graduate school.

The labor force can also expand when people move to California from other states or countries, legally or illegally.

So 126,000 people that were previously unemployed found work last year and another 218,000 new people entered the labor force and were employed.

But this kind of scenario cannot continue much longer. At some point, the low unemployment rate will constrain employment growth and not just marginally like it has to date.

The Robots are Coming. No They’re Actually Here Now.

The tightness of California’s labor market is and will continue to manifest in onerous conditions for firms in recruiting new workers, higher wages and salaries, and more demands by workers for additional benefits, such as more paid time off, a better healthcare plan, or an office with a window.

Rare conditions like these accelerate the incentives by firms to pursue substitutions for human labor with more capital intensive investments. And with the new tax bill, there are additional incentives to explore labor saving automation. You see, there is full and immediate depreciation of capital spending, including investments in technology and equipment (like robots) that could soon or ultimately replace workers.

Consequently, with a fully employed and healthy economy in 2018, look for more news about the implementation of workplace robots, especially in the service industries.

Take Flippy for example, who just this month started working at CaliBurger in Pasadena. The robot combines thermal vision, 3D vision and computer vision. Flippy can cook 150 burgers an hour, flipping them at the right time and removing them from the grill perfectly cooked. CaliBurger says more “Flippies” will be flipping burgers at multiple locations this year.

In late January, the first Amazon Go opened in Seattle. The convenience food store allows shoppers to scan their phone upon entrance, grab whatever items they want off the store shelves, and automatically get charged after exiting the store without needing to stop at a register. In fact, there are no registers and the only employees in the store are those that prepare fresh food, check IDs for beer and wine, and stock the shelves with merchandise.

Not only does the new technology replace human cashiers, it eliminates the wait to check out which can often be as long or longer than the shopping time. Moreover, this new technology also renders shoplifting obsolete.

Another Amazon Go is apparently being planned for a location in the Grove in Los Angeles later this year, with another 5 stores to open elsewhere.

Since Amazon now owns Whole Foods, the “Go” technology might be headed that way in the not-to-distant future.

by Mark Schniepp
February 2018

GDP growth in the 4^th quarter was 2.6 percent, which is in line with expectations. This amount of economic growth is not too hot and not too cold, and at this point in the economic expansion, it’s actually a decent number. Though most of the GDP reports during the current expansion are considered disappointing, the economy continues to hum along producing new highs in many key indicators along the way.

I wrote about this last year and conditions have only improved since. We are at fuller employment, a much higher stock market, higher consumer confidence, higher industrial production, and a faster than expected pace of consumer spending.

Why? Everyone has a job, business confidence and investment are strong, and the world economies are growing including the troubled ones like Spain, Greece, Ireland and Italy.

Last year I called it another Golden Age of the American Economy. These don’t come around often so enjoy it while it lasts. But that begs the question: How long will these times last?

The financial markets sold off sharply on February 2, and again on February 5. What does this mean? Is this a timely omen? Are we now in the midst of an inevitable fall?

As an economic forecaster, I’m always on recession watch, but admittedly I’ve been able to nap a bit at my post because the economy shows no tell tale signs of weakness.

A 2,000 point contraction in the Dow Jones Industrial Average (or a 200 point decline in the S&P 500 index) is actually a healthy sign for this market. The indices have simply risen too far, too fast and for too long without a pull back. We have been expecting some sort of correction for quite some time. Profit taking is inevitable and arguably, the price-to-earnings ratio is on the higher side of history and needs some adjustment.

Fundamentally however, corporate profits are higher and should continue to rise this year because of the new tax policy and a growing world economy. I look for the financial markets to stabilize and resume their upward march this year, albeit with a little more volatility than we’ve seen the last two years.

The probability of recession is unbelievably low and business confidence around the world remains surprisingly strong. Just because the financial markets are going through a correction doesn’t mean that economic momentum has changed.

The recent fire and flood disasters in California will only act as a further economic stimulus providing more opportunities for business expansion this year and next.

So don’t let a few hundred points in the S&P get you down…. not just yet anyway. The economy remains fundamentally strong and economists are generally looking for a stronger growth year in 2018 than we experienced in 2017.

Your List for 2018

• Learn the basics about the new tax reform act and take advantage of it. Speak to a seasoned accountant this year because tax reform rules now apply. Part of this may ultimately be investing in your business with new capital and equipment.
• Technology is changing at an accelerating pace so have your IT up to date and ready to change going forward.
• Automate what you can. Hiring is more expensive and it’s so tough to recruit.
• Business conditions are unlikely to change much this year. There will be more income and more spending because more people are working and earning a higher salary.
• Interest rates will go higher. All forecasts have the 30 year mortgage rate moving higher through the year.
• Nevertheless, home prices will still move higher. If you are waiting for a pullback in prices, it won’t be this year.

by Mark Schniepp
January 2018

The Expansion Continues Through the Year

We are now in month 102 of the economic expansion, eclipsed only in recent times by the March 1991 to March 2001 expansion lasting 120 months. From what we can see at this vantage point in early 2018, the current expansion will at least challenge that record.

The Tax reform bill will result in a net gain in economic growth in 2018, despite all the wrangling commentary you’ve heard over the last 30 days. Tax reform will certainly have a positive effect on corporate profitability. And higher expected profits will drive stock market valuations.

So while it’s hard to see the 2017 stock market returns eclipsed in 2018, barring any episodic change in the world’s economy, the stock market advance is likely to continue. An expanding economy supported by low interest rates, low inflation and improving corporate profits all provide a favorable environment for stocks. The second half of 2018 is less certain, and cracks in the economy that are invisible now may begin to show. Hence more volatility in the market is likely.

Admittedly, tax reform could be modestly negative for housing, especially as the mortgage-interest and property-tax deductions will be scaled back some.

However, real estate is more highly dependent on local factors. Creation of higher paying jobs, for example, are lacking in certain parts of the nation. And though homes are much less affordable in California and other coastal hotbeds, there remains strong demand for higher paying positions, particularly in the technology sectors. The state continues to attract population from other states and abroad. Furthermore, there’s all those millennials living with parents. Are they ready to move out yet?

And incidentally, whichever city lands Amazon’s coveted second headquarters this year could become a sizzling housing market practically overnight, for better or worse.

The global economic outlook continues to improve. The expansion has been underway since 2010 but now almost all affluent nations are growing again. World GDP is forecast to rise 4 percent this year. Global growth will only heighten the demand for U.S. products and services.

What You Should Expect in 2018

Increased profitability and continued job creation

• Due to lower corporate tax rates and a rising global economy

Rising interest rates

• The fed is committed to higher rates, especially in an expanding economy

Rising wages

• We are at full employment and rising wages are a natural outfall of this
• If you need workers this year, recruiting will be difficult

More stock market volatility

• Valuations are high and we are overdue for a correction

An increase in consumer spending

• This is a no-brainer based on higher wages in a fully employed economy. Furthermore, stock market valuations are at record levels, household net worth is at record levels, and average real estate equity per household is just shy of the 2005 record level

A modest increase in inflation

• A symptom of an expanding economy at full employment
• The rate of inflation will be higher in California due to housing

More new homebuilding

• Especially more affordable homes

A Note on Bitcoin

I mentioned it last month but said little. Why? Because there’s really not much to say. The meteoric rise in price has corrected some in recent weeks. Valuations for Bitcoin and other cryptos will ultimately head further south. The question is not if but when because the digital asset has no protection, no intrinsic value, plenty of substitutes, and its price behavior is indicative of a textbook bubble, driven by speculation. If you own bitcoin, you’d better be thinking carefully about an exit strategy. However, I do believe that the general class of cryptocurrencies is here to stay as a modern method of asset exchange.

by Mark Schniepp
December 2017

Well the title should actually read: “It’s the Economy Stupid.” I hope that got your attention because you’re gonna want to read this final feel good edition of the newsletter for 2017.

If you will recall, that was the old campaign slogan of Bill Clinton in 1992. And it’s still true today because it’s the answer to the question of why American households feel so optimistic about their economic futures. Except this time, conditions are stellar rather than lackluster as they were for much of 1992, prompting the regime change from Bush to Clinton.

Despite record numbers of retail closures this year, horrific fires, hurricanes, Kim Jong Un and an ugly World Series game 7 (for the Dodgers), the consumer confidence index rose another 3.3 points in November to the highest monthly reading in a generation, or since December 2000. Americans view their current and future job prospects very favorably; ditto their income growth and their spending levels. Consumers have been the strongest and most consistent source of growth in the current economic expansion.

The increase in household wealth has been stunning as wages are rising and stock and house prices have surged.

Last week’s Gallup U.S. Economic Confidence Index rose sharply, at more than twice the rate as the average weekly gain observed over the past year. Like the Consumer Confidence Index, the Gallup pole measures American sentiment regarding both current and future economic conditions. The Gallup current condition component of the index rose to its highest level since Gallup began tracking economic confidence in 2008.

The confidence indices are now at some of the highest levels ever recorded. Why? Because economic growth is accelerating, everyone has a job, incomes are rising, homes are selling, and the new Star Wars movie is about to be released.

Speaking strictly in terms of the economy, 2017 has been a good year and perhaps the best year during this up phase in the economic cycle, which began in July of 2009.

We are now in year 8 of the economic expansion and by next summer, we will be in year 9. Economic expansions rarely go for 9 years but this one is clearly headed that way. We have no indications at this time that the economy is vulnerable. And fortunately, there are no bubbles, except for Bitcoin.

The economic expansion continues to power forward. Recent economic data have exceeded expectations and in some cases by a wide margin. Along with strong confidence in the economy, the unemployment rate is the lowest since 2001 and October existing home sales rose to their highest level since 2007.

Furthermore, third quarter 2017 gross domestic product growth was revised higher, from 3.0 percent to 3.3 percent. The nation is now growing at the fastest pace since 2014. We are likely to see approximately 2.7 percent growth in the current quarter of 2017 with consumer spending leading the charge. Remember, hundreds of thousands of vehicles need to be replaced in Texas and Florida. And tens of thousands of homes need major repair.

The likelihood of recession over the next six months is now at the lowest level since the risk of recession index was invented, back in 1996. If there is a chance that the economy will change over the next six months, it’s likely going to be faster growth because of impending tax cuts, fire and hurricane rebuilds, infrastructure spending, and a rising stock market which is already at record levels.

The Senate Finance Committee passed its tax reform plan. The full Senate will now consider the bill. The potential for tax reform is a further contributing factor for high consumer confidence and record stock valuations.

OK, Conditions Appear Safe for Now but What are the Seeds for the Next Recession?

A myriad of conditions can produce a recession, but the ones that we can identify in the current environment are these:

• Overly tight monetary policy
• A supply shock
• Another financial crisis

The Federal Reserve is expected to hike interest rates in December and several times in 2018. Despite low inflation of 1.3 percent in the core consumer price index, the Fed will decide that GDP growth is strong enough to boost the short-term federal funds rate to 3 percent by 2020 from 1.25 percent today.

Long-term rates that affect mortgages are likely to stay low if inflation remains contained, which we expect to be the case for a while.

So while the fed is trying to tighten monetary policy, their prescription for raising (normalizing) interest rates is very conservative and cannot be interpreted as “overly” in any sense of the word.

A supply shock is just that, a jolt to the domestic or world economy that is a shock, or unanticipated. We can’t predict one and it’s unlikely to happen. We do see that geopolitical risks are rising especially between North Korea and the U.S., so we are watching this with particular interest. But we can’t otherwise predict a random event.

Another financial crisis is also very unlikely because of regulations put in place since the last financial crisis. Banks are quite healthy today. Nevertheless, international incidents including defaults by entire countries (like Greece or Spain) might always occur, especially in the very slow growth environment of Europe. We don’t see this as a major risk, nor even a minor one. The European economy is actually strengthening, as is much of the rest of the world.

At this writing (December 2017), it appears that we will avert recession for another year. So plan accordingly.