Cal State Fullerton provided an updated outlook on the global, national and Orange County economies at the Spring Economic Forecast on April 25. Despite stock market turbulence, especially during the recent winter, and a more dour mood, the forecast predicts that the economy is likely to continue its decade-long expansion.
After years of modest but sustained growth following the depths of the Great Recession, the most severe turbulence in a decade shook global financial markets as 2018 ended, nearly bringing an end to the storied bull market, while economic indicators demonstrated unsettling weakness that prompted recession talk.
Retail sales declined by 1.6% in December 2018, the biggest drop since the recession; vehicle sales declined for multiple months; stagnation became visible in the housing and construction markets, and even still-positive job gains came to a virtual halt in February. Real GDP for the fourth quarter of 2018, revised downward to 2.2%, was emblematic of the overall slowdown.
As the 10-year anniversary of the expansion, which began in June 2009, nears, polls have shown increased confidence among professionals and economists that further slowing, if not a downturn, is ahead. According to a Wall Street Journal poll, as many as 57% of economists surveyed anticipated the economy will lapse into recession in 2020.
Cal State Fullerton economists Anil Puri, provost emeritus and director of the Mihaylo College Woods Center for Economic Analysis and Forecasting, and Mira Farka, associate professor of economics and Woods Center co-director, take a more optimistic, though guarded, view. “While talent for imagining the worst is valuable (and something we possess in abundance), our view is that recession fears at this point are overblown even as growth is set to decelerate from last year’s path,” they report in their Spring Economic Forecast. “Winter may be coming, but it is not here thus far, and the long summer has yet to run its course. However, this outlook hinges a great deal on the assumption that policy mistakes are avoided: the Fed carefully and successfully navigates the existing dangerous crosscurrents, the U.S.-China trade dispute is resolved quickly, a hard Brexit is avoided and the rest of the world (particularly the Eurozone) acts swiftly to forestall a worse outcome.”
Looking ahead to the remainder of 2019, Puri and Farka anticipate a more cheerful attitude than pervaded as 2018 came to a close, pointing to improved numbers across many indicators, from retail sales to wage growth and the stock market’s rebound, as well as a dramatic shift in the stance of the Federal Reserve and improvements in the trade standoff with China.
“These more upbeat developments should not be mistaken for a return to the robust growth of last year. Indeed, our outlook is for growth to decelerate this year and the next, all the while avoiding a headlong plunge into recession territory,” they say. “With the exception of the yield curve and the excessively low unemployment rate (suggesting tightness in the labor market), none of the other leading indicators are flashing warning signs. The last few cycles have shown that expansions tend to come to an end either because of overheating or because of financial imbalances, neither of which appear threatening at the moment.”
The Case for a Slowdown – But Not a Crash Landing
In assessing the risks to the economy, while acknowledging a number of much-reported indicators, such as the yield curve, Puri and Farka point to the two causes that appear to have undergirded all recessions since the close of World War II: “Broadly speaking, there are two main factors that have commonly brought on the demise of an expansion in the post-war era: overheating (inflationary pressures), which have led to aggressive rate hikes, or financial imbalances (followed by asset price crashes).”
Taming fears of overheating, inflation has remained largely quiescent during the current expansion, dissolving as a concern almost as quickly as it has appeared, while financial imbalances still seem less than threatening, though are certainly evident in certain sectors of the economy.
Puri and Farka point to the composition of debt – in which mortgages comprise 67% down from 74% at the peak of the 2000s housing boom, the high percentage of mortgages going to applicants with top-notch credit scores and a rise in the household savings rate (now above 7.5%) – as good omens.
“Some pockets that appeared frothy a few years ago, such as auto loans, are looking better at present. First, the pace of credit has decelerated significantly, from a torrid double-digit rate of a couple years ago, to a current annualized rate of 3%. The share of subprime auto loans has also stabilized, dropping from an eye-popping 23% to a current 18%,” they report. “More importantly, the subprime auto loan debt, at just $285 billion, represents only 2% of household debt, far below the 10% ($1 trillion) subprime mortgage debt which brought the economy to its knees during the financial crisis. On the other hand, student debt has continued to rise to a jaw-dropping $1.5 trillion and delinquencies are high. But since this debt is federally guaranteed, student debt is unlikely to trigger a financial crisis. Its impact, however, is on higher debt burdens for the young, which will weigh on economic growth over many years.”
Still, believing that the age of the expansion is beginning to manifest, Puri and Farka anticipate slower growth than in recent times with real GDP rising 2.5% in 2019 and 2.2% in 2020. A steady unemployment rate around 3.7% is also expected for both years.
To a Beleaguered Housing Market, the CSUF Economists Offer a More Optimistic Outlook
The housing market, which helped tip the economy into crisis in the late 2000s, has experienced challenges as of late, with housing construction declining for four quarters and home price appreciation slowing.
Unlike a consensus of voices predicting further slowdown or even decline of the market, Puri and Farka strike a more positive note: “We expect the housing sector to move from the steady deterioration experienced last year, to modest improvement in 2019. Mortgage rates have fallen by around 50 basis points compared to mid-last year, thanks in large part to improved financial conditions and a dramatic pivot by the Fed to pause its rate-hiking cycle. Signs of improvement have begun to show: Builder sentiment has turned a corner, mortgage applications have nudged up, existing home sales jumped by 11.2% in February (though they are down compared to year-ago levels) and buyer traffic has picked up. These developments seem to indicate that a potential thaw is in the cards for housing this year. We expect housing starts to average 1.26 million this year and 1.28 million in 2020, while home prices should rise by an average of 2.5% this year and 2.5% in 2020.”
Meanwhile, in Orange County and Southern California…
Looking specifically at Cal State Fullerton’s backyard, Puri and Farka note that job growth in Orange County has come to a virtual stall in early 2019, compared to steady rises in 2018. But the data provided by the state Employment Development Department have been subject to substantial revisions in recent years: Initial weak data have been revised higher in the department’s benchmark revision. The two economists are confident this pattern will repeat this year as well.
With an average annual unemployment rate of 2.9% for Orange County, 4.3% in the six-county Southern California area and 4.2% statewide, the region is experiencing the most dynamic job market picture in decades, and certainly in the careers of a majority of workers.
“While Orange County’s unemployment rate is at a historic low, similar to that of the nation, and labor markets are getting tighter, there is still room for employment to grow. The Great Recession sidelined a large number of working people. While the recovery has brought many of them back to the labor force, there are still many who have yet to make that decision,” they say. “If the participation rate were to get to the pre-recession level, more than 60,000 workers could be added to the labor pool. At the current clip, this should take an additional couple of years, potentially extending the life of this expansion.”
Home prices are near record highs after hitting their highest level ever in May 2018 in Orange County and Los Angeles County, though sales volume has declined, with lowering supply and limitations due to ever-rising prices, while construction has slowed. This is representative of conditions that Puri and Farka believe will be with the region in the near future.
“As of March 2019, the 30-year fixed term mortgage rate stands at 4.27%, or 20 basis points below that of January 2019 and the lowest since January 2018,” they report. “While this will help sales somewhat and the summer months are always more active, the maturing economy and continued high home prices that pinch affordability will keep housing sales volumes lower than in recent years.”
The OCBX Index, comprised through a survey of Orange County business leaders conducted by the Woods Center, provides a still-positive reading of 91.3, an improvement from the beginning of 2019 but still below levels at the start of 2018.
When asked about the key factors in the future performance of their companies, respondents named the state of the economy as the top issue for the second quarter of 2019, followed by government regulation, labor costs, international competition and taxes.
Asked to name the most daunting threats, political turbulence took the top spot, followed by tariffs on Chinese goods and the international trade situation generally, and possible interest rate increases (which seem less likely at present).
For More on the Woods Center
For more on the Woods Center for Economic Analysis and Forecasting or to read the center’s full economic reports, visit the center online. The center provides a midyear report and regular interim studies in addition to their annual forecast. Read more of our articles on the center’s economic forecasts.