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Bruce Norris is joined this week by Dr. Robert Kleinhez. Dr. Kleinhez is the chief economist for the Kaiser Center for economic research. They conduct research on regional state and national economies. He has over 25 years of experience and expertise in the private and public sectors as well as works as a private consultant. He has spoken to local, state, and national audiences, and is a frequent contributor to media coverage on the economy, including coverage on the outlets in California along with Wall Street Journal, CNBC, Bloomberg News, and MPR. Prior to joining the Kaiser Center, he was Deputy Chief Economist at the California Association of Realtors.
Bruce and Robert have known each other a long time and have shared some time at Cal Poly Pomona. Robert would share war stories during the worst of the recession housing downturn, so he said it was good for him to talk now in 2014 where things have turned around. They talked off air about what it was like to say what was next when you were in years like 2008 and 2009. We have turned the Great Recession for a good reason. Bruce asked what was different about this recession as far as the depth of it as opposed to others. Robert said the most obvious to all of us was the performances of the labor market going through this recession as opposed to past recessions dating back to the post World War 2 era.
When an economy goes into a recession, it usually gets in and out and recovers within 24 months of the start of the recession. In the case of the Great Recession, we saw the recession marked at the beginning by the National Bureau of Economic Research starting in December 2007. It was only in this most recent labor market report for May 2014 that we finally recovered all the jobs that were lost during the Great Recession. Comparing a 7-year recovery time in this economic cycle to the typical two-year recovery time is just one way of gauging how severe the recession was. When he says this it also has to say some other things. For seven years there has been more labor than demand. Bruce wondered how this has affected people’s ability to get raises or hired back at the same wage when they lost their job. Robert said we saw the unemployment rate nationally get up to almost 10%. Now it is at 6.3%, and we think the labor market should be right around 5 ½-6% over the long run time frame.
There were so many people out of work, and there were also at least some people who were out of work and whose skills became obsolete over time. When coming back to work, they may not have been able to find the same kinds of jobs. A lot of middle wage jobs have been hit hard over the last several years, especially during the recession. These are jobs like manufacturing and administrative where a lot of the activities have been taken over by some type of technology. The middle category of workers was really hard-hit going through the recession and even before it started. This was a category of jobs that was most at risk. We have seen jobs come back at the low wage, and these are creeping up ever so slowly. We have also seen jobs come back at the high end of things where you often have skilled workers in a profession. These jobs have come back strongly and are where most of the pay gains have occurred.
Bruce asked if when we count jobs and say we have recovered all the job losses, does it include people who are working part time? Robert said they are just looking at head counts of people who are on some type of payroll in the United States. To say in the month of May that we recovered all the jobs lost during the Great Recession is simply to say the job count in May 2014 slightly exceeded the peak job count that prevailed prior to the recession. We still have a somewhat high number and share of workers who are working part-time. This is true for people who work part-time but would like to work full-time. That share has come down over the last couple years. Today’s report from the labor market indicates that job openings have really picked up markedly. When you look at the collection of indicators we have out there right now about the labor market, he would expect to see not only an uptick in hiring in the coming months, but also an increasing trend of full-time employment as well.
Bruce said there is a strange category that is no longer included in unemployment called “No longer looking.” Bruce asked how big a segment this is and how you even qualify for it. Robert said the information they receive about the labor market comes from two sources. The one we are talking about right now is the household survey where the Bureau of Labor Statistics calls and interviews 50,000 households each month to find out about people of working age and whether they are working. If someone is of working age but indicates they are not even working, then the person will be classified as such. If the person is looking for work but not employed, then they would be classified as unemployed. If they are working, regardless of whether it is full-time or part-time, then they will be regarded as employed. It is not necessarily the best way of measuring things, but it is what we have to work with. The headline rate of 6.3% mentioned earlier does not included discouraged workers who are working part-time or may have stopped looking for work. That percentage is a little over 12% as of May.
Bruce asked if we had always counted it this way historically, how would we stack up and would 12% still not be so hot? Robert thinks nobody would be satisfied with a 12% unemployment if that were the headline you heard about every month. Bruce asked if this is why they changed talking about it this way, to which Robert said it has always been reported the same way. However, he thinks there has been great tension directed toward some of these broader measures of unemployment, especially going through this particular recession having been so deep. It seems to have displaced many more people for a far longer period of time compared to past recessions. This bears in mind that this economic cycle and the labor market recovery from the cycle is quite a bit longer than what we have seen in the past.
They mentioned how things are improving, so Bruce wondered if the first quarter GDP growth for 2014 surprised him. Robert said it did and that most economists were expecting that at the beginning of the year we would be seeing strong growth throughout the year. However, we did not anticipate the severe weather that affected much of the country. It did not affect Southern California much, but it did put a damper on things especially in the local economy. If anything, he would say the GDP reading for the first quarter was and will probably prove to be an outlier. They were looking at much better growth in the remaining quarters of 2014 and going forward into 2015. Last year we saw growth in GDP of just under 2%. This year we are looking at a 2 ½% growth rate for 2014, even with the small first quarter numbers. This means we have to grow it faster than 2 ½% the remaining quarters of the year. Next year would have to be even a little bit faster.
Bruce asked if the pace of growth in 2015 will be such that we should have an impact on interest rates. He said that while everybody likes to have low interest rates, when the economy heats up or moves into another gear, it is not uncommon for the financial markets to anticipate that and the possibility of inflation. This in turn typically drives up interest rates. What is going on right now is a heavy intervention on the part of the Fed to keep long rates low in the form of their bonds buying the QE 3 activity. They are tapering this off. Robert said they have heard this term used many times in the news. It is expected by the end of the year the effort to keep long rates low will be over with. This means things like mortgages should float more freely in response to market conditions. The Fed will still be keeping a low short-term rate policy. It is Fed funds rate, which is effectively at 0 right now, and it will continue to be low well into 2015. They are very much aware of the fact that while the economy is picking up, it is still in a fragile state.
When they first talked about pulling back the cookie jar, the 10-year T-bill took off and got into mid-freeze. Today it is at about 2.6. Bruce asked if this is part of the natural market reaction to where they thought interest rates could be supported at 3 ½, then the market was not as good as we thought and caused them to come back down. Robert said yes and that the markets, intervention, and situation abroad all play a role in determining interest rates in general. The ten-year is the long-run direction of interest rates. Early last year they heard they announcement that they would be winding down the Fed bond-buying effort that caused an immediate spike in rates. Things tapered off, and they actually backed off from that initial announcement and reassured everybody around the globe that it was going to be a deliberate and slow winding-down process.
This smoothed things out, but one of the concerns is what will happen abroad as the Fed winds down these programs. Emerging markets, which benefited from our low interest rate policy, are potentially going to hit some headwinds. They are looking at the flight of capital into their economies turning back and leaving and coming back to the safe haven of the United States as our rates increase. Just about anywhere around the globe where there is any kind of unrest and news of unrest, we have heard more than we would like to this year. That tends to drive capital from other points around the globe into the safe haven in the forms U.S. treasuries. This tends to keep interest rates low. We have that working in our favor even as the Fed winds down. If the economy grows as we expect it to, roughly 3% this year, then that would tend to lift interest rates no matter what.
Bruce asked how responsible these low interest rate policies have been to asset prices, both real estate and stock. Robert said this is indeed one of the big questions of whether this policy was well-intentioned and if they should have stuck with it as long as they have. His sense was the asset markets have benefited from the low interest rate policy and money is seeking the best possible rate of return. This is whether it is a domestic investor or an international one. In the absence of return on fixed-rate assets, money flowed to the stock markets, equity markets, and real estate. This certainly helped to prop up home prices and enabled us to hit new highs in the various stock market indexes as we have been seeing in the last couple of days. He would definitely draw a link between the two.
By and large, this has made people feel a lot better about their personal situation. It has probably made pensions feel better about their situation as well. When we talk about the psyche or sentiment that both consumers and businesses have. The operative word here is “fragile.” It has improved over the last couple of years, but both consumers and businesses seem to be inclined to look over their shoulder and see when the next bad thing is going to happen. Meanwhile, an outstanding performance in the stock market certainly helps things. On the consumer balance sheet, it has improved the financial asset side of things and households are still looking for a more pronounced recovery on the real estate side of things. If we take a look at the typical household, they are not so much invested in stocks and bonds as they are the single asset they call their home that they own. The recovery in the housing market is more important for a broad-based economic recovery than what is happening in the financial markets at the present time.
Bruce asked what is going on in the California economy versus the U.S. Robert said California had a higher unemployment, quite a spread with the nation’s number, and it has gradually gotten closer and closer. However, California still has a higher unemployment number than the U.S. It is true that our unemployment rate is higher now, and it is typically higher than the national unemployment rate. This is also true for many of the local county economies as well. The good news is the California economy has been growing at a faster clip than the national economy. Whether you take a look at the equivalent of gross domestic product or gross state product, for California we have been growing it better than 3% for the last couple years versus 2-3% for the nation as a whole. California’s economy based on that metric is growing faster.
When you take a look at the labor market and non-farm job numbers for California, we have been growing at least two percent over the last couple years. At the same time period, the nation has been growing about 1.7%. We are gaining ground against the national economy, and our unemployment rate has come down rather quickly. It is good to report that it is down to 7.8% at the present time. The long run average is about 7.5-7.7% for the state versus 6.1% for the nation. When you take a look at California, you can tell that through thick and thin we tend to have a higher unemployment rate.
Bruce asked when we have a gap as close as it is right now, do we tend to have any outward migration problem or inward migration from the domestic side? Robert said when we take a look over the last few years, we did have some out migration but it paled in comparison to what occurred in the 1990s. The difference between the two was in the 1990s, with the defense cuts and restructuring that took place in Southern California, so much of that occurred there but not elsewhere in the rest of the country. People could not find jobs here, but they could find jobs elsewhere so there was a huge movement and migration out of the Southern California region in particular to other parts of the country. This time around everybody shared in the pain, so we did not see nearly the same out migration at the wake of the recession that we had seen back in the 1990s. Good or bad, this is one of aspects of this recession and one of the reasons the unemployment rate became so high this time around since the labor force stayed put. It did not leave and go to other parts of the country the way it did back in the 1990s. We still have some out migration occurring, but it is nowhere close to what we saw back in the 1990s when we were going through a more difficult set of circumstances.
Bruce said one of the drivers for Riverside and San Bernardino Counties is usually new construction of homes. By and large this has not happened yet, so he asked Robert what he sees the prospects as being for the next couple years. Robert looks at a couple different measurements when looking at the housing market. When we are talking about new home construction, we are looking at permits that fell off the edge during the course of the recession. This was true nationally, statewide, and locally. The number of permits really dropped off in the Inland Empire, and for the state as a whole we typically average 140,000 plus building permits. This is for both single and multifamily. In boom years we get over 200,000, but in the worst years of the recession the statewide camp was down under 40,000. Last year we were a little bit over 80, and this year our projection is for 112,000 permits for all of 2014. As of the first quarter of the year, we are still behind by 15%. We have some ground to make up here. If you look at the Inland Empire and see all the problems relating to the housing crisis where we are really focused on the Inland Empire, it is an area where permits really fell off the cliff. Projections are they will come back much more slowly than in the state as a whole. We lost 1/3 of the construction jobs statewide during the course of the recession that were in construction. We are getting them back very slowly. Roughly the same percentage of jobs in construction was lost in the Inland Empire, but they will come back even more slowly because of the slow return of building permits.
A construction project not only hires people who do that work, but it is the kind of job that creates other activities that are very positive. Bruce asked if getting construction back is job #1 for the California economy. Robert said it is very important at all levels beginning at the national economy and down to the state and local economies. They recently took a look at the international trade situation because goods moving in is so important to the Southern California economy, including the Inland Empire. If you take a look at the container activity that preceded the Great Recession and where we are now, the run-up in container activity coming through the two ports in LA and Long Beach coincided with the run-up in building activity as well. When building activity dropped off, so too did the container activity. We are talking about building materials as well as the things that go into the homes.
Recovery and housing, specifically a recovery in new home construction, is very important for the overall economy. You build those homes and employ construction for workers and others who support those jobs. The people who buy those homes equip those homes with furnishings, so there is a tremendous ripple effect that works its way not just through a local economy like Riverside or San Bernardino County. At the national level, it is all important to what we expect to be a much faster pace of growth next year and in 2016.
Bruce asked Robert what he thinks of the volume of sales. The projection from CAR was around 440, and they had been bouncing around 350-360. Bruce asked Robert what he believes to be the cause for this. He said the first cause is the constraint on the supply side. He also thinks that coupled with what is happening on the policy front, including requirements for mortgages and the Fed movement to wind down the program, are creating uncertainty for both consumers and would-be sellers. This is whether it is the new home market or the existing home market. Supply and uncertainty are the two things that are contributing to a weaker than expected housing market this year. Bruce is really familiar with charts, and he has never seen a chart of uncertainty. This is exactly what is happening, but you cannot track uncertainty. It is hard to know when people are going to stop feeling uncertain.
Robert thinks there is pent-up demand. With low interest rates and prices that are still well below peak, there is a lot of room for affordability and for home sales or demand to show itself. If there is hesitation, it will show up both in terms of weak supply, both new and existing. It will also cause people to think twice before they list their home. Meanwhile, the people who might be thinking about listing their home are seeing that with double-digit price increases in Southern California they have an opportunity to recoup some of the equity they lost during the recession. There are a lot of things working against the supply side. Because prices are moving so slowly and sales are uncertain, it is creating a cloud of uncertainty that is putting a lot of participants off at the present time.
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California Real Estate Investing News is a post from: The Norris Group