BURSTING Bubbles or SOARING Balloons.
Written by Peter Strauss of Iconic Investments
Iconic Investments attended the fourth quarter UCLA Anderson Forecast on December 6th. The theme of this forecast was "Sunny 2018, Cloudy 2019." This article will summarize what was discussed at the forecast and provide the outlook of the UCLA economists and Wall Street strategists. 2018 seems optimistic, 2019 not so rosy.
UCLA Anderson Economist David Shulman's national perspective:
Gross Domestic Product: For the last five consecutive quarters, the U.S. economy has been experiencing an unprecedented GDP growth rate of 3%. Shulman predicts that we will get a few more quarters at 3% growth, but growth will begin to fade in 2019. The reason being, Shulman said, is: "The U.S. economy is running out of labor; it’s hard to get economic growth with a fully employed economy.” Currently, he said, the GDP is largely being fueled by equipment spending by large corporations.
Unemployment: On a national level, UCLA predicts that the unemployment rate will be at 3.8% by the end of 2018. Some Wall Street analysts predict it will go as low as 3.5%. The question is at what rate wages will continue to rise. This will have an effect on the unemployment rate moving forward.
Interest Rates: The new chair of the Federal Reserve, Jerome Powell, will continue to normalize interest rates and follow the same course as Janet Yellen. Shulman predicts that the Fed will issue three rate hikes at 25 basis points (per hike) in 2018, raising the Fed Funds Rate to 2.25% by the end of 2018. He expects four rate hikes of 25 basis points (per hike) in 2019.
Balance Sheet: When the Fed did quantitative easing, it increased the Fed’s balance sheet from $800 million to $4 trillion-plus. This was done through mortgage and Treasury- backed securities. The Fed will continue to shrink the balance sheet by letting older securities come due, without being replaced, in amounts ranging from $20 billion–$50 billion per month. Forecasting the effects of shrinking the balance sheet is difficult since this has never been done before.
Inflation: Inflation is currently running around 2.5%, above the Fed’s target of 2%. Therefore, the Fed will continue to normalize interest rates.
Wages: We've had an acceleration of wage growth to 4%--well above the norm. The problem lies in the fact that it’s difficult to find labor. Companies like Target are increasing wages to attract new employees.
UCLA Anderson Economist Jerry Nickelsburg’s forecast on California:
Economy: The California economy is growing at a quick pace of 2–3%. Moving forward, he predicts California’s economy will grow at a slower pace closer to 1–2%. Part of the reason for the decline is that imports and exports are relatively flat at California’s three major ports. This sector experienced explosive growth, but now we will continue with a slight upward trend. As many real estate owners/developers are experiencing, it’s hard to find good labor. Contractors and vendors have more jobs than they can handle. Therefore, labor costs have gone up! We have reached full level of employment, making it difficult to bring new people into the workforce. California’s growth will continue, just at a slower pace relative to the earlier part of the expansion.
Implications of a Tighter Labor Market? Minimum wage will increase, causing more businesses to seek automation on lower paying jobs.
Housing: The Trump tax plan will make owning a home more expensive, causing the demand for housing to decrease and prices to fall. This will also result in the loss of equity for current homeowners. Home prices will fall because the available income-to-purchase ratio will be lower. In addition, there will be less incentive for developers as the housing market softens.
2018 California Forecast:
•Unemployment -- 4.6%
•Payroll Growth -- 1.2% (Slightly faster than the U.S.)
•Personal Income Growth -- 3.1%
Modest Returns Ahead
The focus of the December UCLA forecast was the financial markets. Two key speakers from that sector were: Harlan Spinner, senior vice president of UBS Wealth Management, and Christopher Harvey, head of equity strategy for Wells Fargo Bank.
Question: The stock market is up 25% since the election in November 2016. PE ratios are at historic highs. Is the exuberance rational or irrational?
Harvey believes that the PE ratios are rational now. They were low for many years and should have been higher sooner.
Spinner said the PE ratios are rational based on where we are at today. The market is responding to tremendous growth in earnings, not to Washington's policies. Moving forward, we will have modest growth. The long run rate for the equity market will have lower returns and slightly higher volatility. He expects returns of plus or minus 8% forward from current levels.
Question: UCLA predicts three Fed tightenings in 2018 (75 basis points). What do you predict?
Spinner said: “UBS's forecast goes out 12 months. We see the Fed raising rates two times in 2018, and the expectation on the 10-year Treasury at the end of 2018 is 2.80%.”
Harvey said: “Our year-end target (2018) for the 10-year Treasury is 2.55%. Part of what we are seeing is that our inflation expectation is lower than yours, and we are talking about a curve flattener. With inflation trends, it's hard to see a very big spike up.” Rates will be flat for three years."
Question: Do fixed-income investments have a role in an individual's portfolio?
Spinner and Harvey agree that individuals should have a portion of their assets in fixed- income investments. It's a great hedge against the economy. If the U.S. economy crashes, it still generates the same return.
Question: What sector of stocks do you like?
Spinner and Harvey said they like utilities, food, beverage & tobacco, and financials -- especially in the rising interest rate environment.
Question: What are your thoughts on Bitcoin?
Spinner and Harvey both said Bitcoin was pure bubble and speculation; however, they both were not sure whether it would go higher or lower. They said it will never be a currency for three reasons:
• Governments won't accept it as a form of payment to pay taxes.
• It is highly volatile and won't be used for employee payroll.
• Fixed currencies don't work because there is an infinite amount of Bitcoins.
Iconic Investments
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Encino, CA 91436
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W: www.iconicinv.com
Iconic Investments is a Los Angeles-based boutique commercial real estate brokerage firm focusing on multi-family properties of 15 to 100 units throughout Los Angeles in all different sub-markets. Iconic represents multi-family property owners in dispositions, acquisitions, and 1031 exchanges.