In light of recent stock market volatility and the ongoing expansion, Anil Puri, director of the Woods Center for Economic Analysis and Forecasting, and Associate Professor of Economics Mira Farka, Woods Center co-director, presented their annual spring update of the Economic Outlook and Forecast at the Hotel Irvine on May 3, examining the state of the global, national and local economies.
After several years of relative tranquility, especially in 2017, financial markets have been caught in increased volatility in recent months, which has dominated headlines despite a continuing economic expansion resulting in some of the highest employment rates in the post-World War II era and a historically long slog of continuous GDP growth.
“2017 was a remarkable year. Stock markets around the globe soared, volatility was at historical lows, inflation remained subdued, and monetary policy continued to remain accommodative across the world,” report Puri and Farka.
“Alas, 2018, has ushered in a dourer mood. Retail sales slumped for the third straight month in February, vehicle sales have plateaued, construction took a step back earlier this year and home sales continue to struggle. More importantly, market volatility is back with a vengeance as if making up for lost time last year when it was conspicuously absent,” they say.
While some recent point changes on the Dow Jones Industrial Average have been dramatic, such as the record-breaking 1,175.21-point plunge on Feb. 5, these declines are relatively common historically when taking into account the much more modest percentage drops due to the high values of today’s share prices.
Puri and Farka note a number of concerns that have worried investors, including fears of inflation, geopolitical trade shifts wrought by the Trump Administration and recent troubles in the e-commerce sector.
“Our view is that market hysteria on a number of these issues is overdone, at least at this point,” say Puri and Farka. “While risks are elevated compared to a year ago, we expect the economic expansion to continue apace in the U.S. and the rest of the world this year and the next. The economic backdrop is solidly positive and fundamentals point to continued, and in our view, amped-up growth in the short-term.”
Among the signs for optimism are consumer and business sentiment remaining at all-time highs, rising business investment, the bounce back in the real estate market from the depths of the Great Recession, rises in wages and continued tightening in the labor market.
The Economic Expansion Nears Record Territory, But Headwinds Loom
The recovery from the Great Recession, once a tepid upward trend following the most ferocious downturn since the Great Depression, has since blossomed into a robust expansion that will set records for the longest growth spurt since World War II if it continues until at least June 2019, which Puri and Farka anticipate. They called for a 2.8% rise in GDP this year and a 2.9% jump in 2019, buoyed by continued strong fundamentals and fiscal stimulus.
While market volatility might be uncomfortable when compared to the recent calm, this does not necessarily equate to hard times on the horizon, though Puri and Farka expect a bumpy ride in the markets over the near-term.
“The return of volatility is nothing short of normal at this stage of the business cycle. In fact, its absence last year was an abnormal phenomenon, spawned primarily by the extraordinary central bank liquidity sloshing around the world in the early and mid-stages of the recovery,” report Puri and Farka. “The vast amount of liquidity made it easier to navigate financial and macroeconomic risks, smoothing edges and sidestepping rough corners. However, as the transition to a less accommodative monetary policy continues and potentially ramps up, some repricing of risk is certainly expected, especially as fundamentals become the primary drivers of valuations. Higher volatility and periodic advances and retreats in equity markets are expected to characterize the investment horizon this year and the next.”
Looking at trade tensions, Puri and Farka take a more positive view than the consensus, noting that China’s trade policy has been less than fair and the tariffs proposed by the Trump Administration could ironically result in freer and fairer trade with Asia’s leading economic superpower. NAFTA renegotiations also have the potential to result in a needed modernization.
Monetary policy features as the greatest near-term risk for the economy, according to Puri and Farka: “We are now in a new regime, having transitioned to a higher-growth, higher-inflation, higher volatility environment from an earlier regime when all three were repressed. The significant dose of fiscal stimulus administered this year, both in the form of tax cuts and spending increases should juice up the economy further at a time when economy is already at (near) full employment. While we don’t think the economy is overheating, at least not yet, things are certainly heating up. With inflation and growth likely surprising on the upside for the balance of the year, we anticipate the Fed to tighten faster than what markets expect: four rate hikes this year and four in 2019. Faster monetary tightening, which is typical in the late stages of an expansion, coupled with a waning of fiscal stimulus in early 2020, will greatly increase the odds of a recession, or at a minimum, bring the expansion to a screeching halt.”
Taking a longer view, the growing federal debt stands as a leading threat, with meaningful entitlement reform unlikely given the current political climate.
The Southern California Perspective
Irregularities in the data provided by the California Employment Development Department notwithstanding, the Southern California labor market continues to move closer to full employment, with the statewide unemployment rate declining to 4.7%, the lowest since the 1980s. Unemployment in the Southern California region is also 4.7%, which is the lowest such figure in more than a decade.
Orange County experienced a jobless rate of 3.5% in 2017, remarkable considering that more people are attempting to join the labor market, either as employees or job seekers. “While the unemployment rate in the county continues to head down, we don’t see severe labor shortages yet because of improving labor force participation,” report Puri and Farka. “After declining through the recession and in the early stages of the recovery, the rate of labor force participation appears to be heading back up. This is a reflection of similar trends nationally.”
Though slowing down from the growth rates of recent years, job growth has continued in all counties of the region, including the Inland Empire, where the jobless rate has declined to a historically impressive 5.1%.
Looking at Orange County specifically, a relative slowdown in population growth, high housing values and increased homelessness have captured the headlines. Puri and Farka noted that these factors are relatively interconnected. While the rate of housing price increases may moderate, an appreciation of 5% this year and 4% in 2019 is still expected.
“Given the outlook for continued housing price increases, higher mortgage rates and tightening requirements, the condition of homelessness in Orange County will worsen before it gets better,” say Puri and Farka. “The numbers of homeless has lately been on the rise in both L.A. and Orange County. In an odd way, the heightened homeless issue may be a reflection of high living costs and residents’ reluctance to leave Orange County. Los Angeles County has undertaken significant efforts to alleviate the homelessness issue including a county-wide tax and other long-term efforts. However, Orange County has yet to fully appreciate in its public policy arena the full dimension of the problem before viable solutions can be devised.”
For More Information
For more on the Woods Center for Economic Analysis and Forecasting or to read the full report, visit the center online. In addition to the midyear report, the center provides an annual report in October or November, as well as interim updates throughout the year.