Citing “improved financial conditions, a better housing and employment outlook, some relaxation of trade tensions and a modest improvement in business fixed investment,” the UCLA Anderson Forecast has upgraded its national economic forecast through 2020. Instead of calling for 1% real growth for 2020, the forecast now expects growth to be on the order of 1.7% on a fourth-quarter-to-fourth-quarter basis.
“After going on a separate track from business investment, we forecast a slowdown in consumer spending, largely coming from much weaker automobile sales as credit tightens in that sector,” senior economist David Shulman writes. “Overall, the interest rate environment, aside from auto credit, will remain benign. But make no mistake, although we have lowered the risk of a recession, the second half of 2020 remains problematic for the economy.”
The Anderson Forecast is now somewhat more optimistic than it was just three months ago, as a number of fears have been eased. Stock prices have reached new and decisive highs; the Federal Reserve cut its policy rate by 25 basis points and is supplying additional reserves into the banking system; the yield curve has returned to a positive slope; housing activity has exceeded expectations; employment growth (as evidenced by the October jobs report) is also better than expected and looks to be growing faster going forward; and there is decreased pessimism on the trade front as an interim U.S.- China trade deal appears on track and the USMCA trade treaty with Mexico and Canada has made progress in Congress.
The forecast has retreated from its long-held expectation of a 3-2-1 economy, wherein GDP growth on a fourth-quarter-to-fourth-quarter basis would be 3% in 2018, 2% in 2019 and 1% in 2020.
“We now anticipate that growth in 2020 will be 1.7% compared to 1.25% previously,” Shulman writes. “So, call it roughly a 3-2-2 forecast, with 1.9% growth in 2021.”
Shulman makes clear that there remains a significant risk of recession in late 2020, though the risk is not as great as it was in prior forecasts.
“For those who say that we can’t have a recession in a presidential election year, I would note that recessions occurred in 1960, 1980 and 2008, all presidential election years,” he writes.
Shulman points out that for the past year, economic performance has diverged as strong consumer spending masked significant weakness in business investment. This, he says, is a “two-track economy,” somewhat surprising because most observers (including to some extent the UCLA Anderson Forecast) assumed that the reduction in business taxes (as a result of the 2017 tax act) would spur spending on capital improvements. This has not occurred, as trade tensions made planning ahead problematic, particularly with respect to global supply chains.
“Indeed, real business fixed investment actually declined in both the second and third quarters of this year,” Shulman writes. “Nevertheless, we think the worst is over and we anticipate a modest recovery over the next two years.”
The California report
The improvements in the national economy, along with associated optimism in the national forecast relative to the past few quarterly reports, have made a positive impact on the California economy. The key word is “relative,” as it would be a mischaracterization to call the latest state forecast much of an improvement.
“Since national economic growth is slowing at a slower rate than the forecast three months ago, the California forecast is now slightly stronger than predicted last September,” writes UCLA Anderson Forecast Director Jerry Nickelsburg.
To be clear, however, “slowing at a slower rate” is still slowing.
Nickelsburg’s analysis, thus, is largely one of perspective. On one hand, growth in California is slowing. On the other hand, this is, in part, because unemployment rates are very low.
“Therefore, it follows that the rate of hiring should slow down,” Nickelsburg writes. “Through April of this year, that had not happened. Indeed, the rate of hiring for non-farm payroll jobs increased by 0.2 percentage points from 2018’s hiring rate. At some point, capacity constraints become binding, and with the October job numbers in place, there are indications that [the slowdown in hiring] has occurred.”
According to Nickelsburg, the economic news remains positive, in spite of trade tensions between the United States and China. As an example, the July 2019 countywide unemployment rates from Marin to Santa Clara counties are below 2.2%; from Sonoma through the East Bay are below 2.7%; and in Southern California, Orange and San Diego are at 2.8%.
In 2020 and 2021 California’s total employment growth rates are forecast to be 0.9% and 1.3%, while payroll jobs will grow at rates of 1.9% and 0.9%, respectively. These reflect the stronger growth in payrolls over the last year, even while total employment growth was weaker.
“Home building will be lower by about 5,000 units in 2020 than previously forecast,” Nickelsburg writes, “but we remain optimistic with regard to 2021 new residential construction.”
Weakness in home building, even with the new eased regulations and zoning, means that the prospect of the private sector’s solving California’s housing affordability problem over the next three years is nil, he writes.
Special report: City Human Capital Index update
In 2012, the UCLA Anderson Forecast developed the City Human Capital Index to calculate the weighted average of education attainment of adult residents by various geographic domains. The goal was to provide a barometer to measure and compare human capital across regions and over time. The Anderson Forecast found that the index correlates with other socioeconomic variables, such as median household incomes, poverty rates and housing prices. The current report is based on data through 2017, the most recent available.
UCLA Anderson economist William Yu writes that human capital levels have been steadily improving over the past several years for most metro areas, but the distribution of human capital is far from equal across the country. For the youngest adult age group, those aged 25 to 34, California had the highest human capital gain from 2011 to 2017 among the 50 states, possibly because of the tech boom that attracted a highly educated workforce during the same period.
According to Yu, larger metro areas tend to have higher levels of human capital. Urbanization and the agglomeration effects in the 21st century help bolster the size and human capital of a bigger city at the cost of shrinking and fading smaller towns. The exceptions are so-called college towns, where higher education is the major local industry, attracting students and employees with higher human capital potential than the rest of the country and the world.
Special report: Is a recession coming soon?
In a companion essay, UCLA Anderson Forecast director emeritus Professor Edward Leamer addresses the issue of recessions. Leamer defines the terminology and answers key questions, including who should worry about a recession and whether or not a recession is on the way soon.
While noting that the “Wikipedia definition” of a recession is a “business cycle contraction when there is a general decline in economic activity,” Leamer offers his own, preferred definition: “A recession [is] a period of time in which markets fail and allow sharp increases in idleness of labor, capital and land.”
As for who should worry about a recession, Leamer is blunt.
“Everyone should,” he writes. “Some of your family members may lose their jobs; debt service may be difficult; you might lose your home. Even if your revenue flows are not threatened, the value of all your assets is. A recession is a time that is hard on leverage but great for those with cash to acquire new assets.”
As to whether or not a recession is coming, Leamer is less definitive. He acknowledges a few reliable recession precursors, including a decline in weekly hours in manufacturing and a bottoming-out of the unemployment rate at low levels, though he says by themselves these factors do not raise the probability of a recession to a high level.
Special report: Public pension plans
In a third companion essay, UCLA Anderson economist Leila Bengali examines public pension plans. Public pension plans are the retirement plans for employees of state and local governments. Bengali notes that such plans have assets (such as investments in equities) and liabilities (promised benefits to employees), and that unfunded liabilities have grown over time, particularly during past recessions.
In her conclusion, Bengali suggests that plans have not, on average, recovered from the last two recessions, where “recovered” means returning to 100% funded.
“Plans are long-lived and thus have the ability to ride out short-term business cycle swings, but also face the challenge of recovering from downturns while looking decades into the future,” Bengali writes.
She writes that the current and projected environment of low-bond returns further hamper recovery efforts, potentially putting pension plans under pressure to further reduce assumed returns, which subsequently increases both the value of unfunded liabilities and the difficulty of returning to fully funded status.
UCLA Anderson December Forecast Conference: Financial outlook for 2020
In addition to presentations of the U.S. and California forecasts, the December 2019 Forecast Conference, sponsored by RSM US LLP, features several panels and a keynote address by Vijan Srinivasan, chief investment officer of Scarsdale Capital LLC. The conference takes place on December 4, from 7:30 to 11:45 a.m.
UCLA Anderson Forecast is one of the most widely watched and often-cited economic outlooks for California and the nation and was unique in predicting both the seriousness of the early-1990s downturn in California and the strength of the state’s rebound since 1993. More recently, the Forecast was credited as the first major U.S. economic forecasting group to declare the recession of 2001.