Economic Update (Monday, July 20, 2020)

[Lloyd Segal]

                                                                Economic Update
                                                            (Monday, July 20, 2020)

In a previously unimaginable turn of events, the Los Angeles economy has tumbled from record highs to pandemic-driven lows in less than a year. Even in the darkest of days, however, our city’s business community is showing signs of resilience. Retailers and restaurants are adapting to lockdowns and re-openings (and re-closings), with curbside service, expanded takeout, and plenty of innovation. While the Covid-19 pandemic has certainly taken its toll on our city’s nightlife, tourism and hospitality industries, Los Angeles figures to shine again as our economy slowly reopens. Let’s see why…

Consumer Price Index. First the good news. Following three months of declines, the consumer price index (CPI) turned higher in June, rising 0.6% to tie the largest monthly increase since 2009. Gasoline prices (+12.3%), beef (+4.8%) and physicians services (+0.5%) lead the rise. Energy turned higher for the first time in five months, rising 5.1% in June as fuel prices offset a decline in the electricity index. Food prices increased 0.6% in May, with rising costs for meats, poultry, fish, and eggs leading a rise across most major food categories. In addition, prices for hospital care (+0.4%), home furnishings (+0.4%), and airline fares (+2.6%) were key contributors, while heavily COVID impacted industries like autos and recreation continued to have price declines. But the Coronavirus and government-mandated shutdowns remain a factor clouding the data. Businesses continue to operate under restrictions of reduced capacity, which looks likely to continue for the foreseeable future. Expect prices to continue to rise in the months ahead towards the 2% - 3% annual pace of inflation that was in effect before the Coronavirus wreaked havoc on global economies. While we are still battling the virus, the worst – at least from an economic perspective - appears to be behind us, and indications from the employment front suggest that the economy bottomed out in May, making the COVID recession one of the sharpest recessions on record, but also the shortest. The worst economic quarter in the post-World War II era is behind us, the economic recovery has begun, and the question now shifts to how quickly we recover.

Retail Sales. Retail sales rose 7.5% in June from May. Just two months ago, retail sales were down 19.9% from a year ago. Now, in June, retail sales are up 1.1% from June 2019. For more perspective: from February (before the COVID shutdowns started) to the bottom in April, retail sales fell 21.7%. Now, with the increase in June, we are only 0.6% below the February mark. Still down, but a strong start to the recovery process. Ten of thirteen major retail categories had gains in June. For example, clothing fell by 86% from February to April, and led the way higher in June up 105% from last month and up 467.5% since the April bottom! Autos rose 8.2% in June as car dealers followed the rest of the country in continuing to reopen their doors along with restaurants (albeit, outdoor seating). Non-store retailers – the one group that rose, rather than fell, throughout the shutdown – fell 2.4% in June, but is still up 23.5% versus a year ago. Food & beverage sales declined 1.2% in June but are up 12.4% from a year ago, which means we’re drinking less, but still alcoholics. What matters right now is the path forward for retail sales, and we have started down that path at a healthy clip.

Mortgage Rates. Well, it has finally happened! The average for a 30-year fixed-rate slipped below the psychological threshold of 3.00%. Interest rates fell to 2.98%. These rates are the lowest level in almost 50 years of recordkeeping by Freddie Mac for the third straight week (and the seventh time since the coronavirus outbreak began roiling financial markets). The tumble comes as the Federal Reserve holds its benchmark rate near zero and continues buying mortgage bonds as part of its plan to stimulate the economy. As you can imagine, the lower borrowing costs have drawn a flood of applications for refinancing and new purchase loans, so our friendly mortgage brokers are happy. Plus the dip below 3% could prompt even more Americans to apply for loans. In May, when the Federal Reserve started buying mortgage securities, analysts predicted that rates could drop below 3%. Now, there’s speculation that the slide could continue, so get ready for even lower rates! Despite historic low mortgage rates, risks still abound in the housing market. With credit standards tightening amid high unemployment and fears that the economic recovery is stalling, some potential buyers won’t qualify for loans or could struggle to find homes in their price range. That could hamper what has been a relatively strong housing market. Ultimately, of course, the direction of the virus is going to dictate the course of the housing market and our economy.

Housing Starts. Housing starts increased 17.3% in June to a 1.186 million annual rate. This was the largest monthly gain since 2016, as the recovery in new construction continues. Looking at the details of the report shows that the gains were broad-based, with both single-family and multi-unit construction posting healthy increases. Those measures are now down only 3.9% and 4.1% respectively from year ago levels, demonstrating the remarkable resilience of the housing market in the aftermath of the pandemic. That said, builders are still dealing with headwinds which have been hampering a sharper rebound. While home builders have been classified as "essential workers" in most areas of the country, regulations still require fewer people per crew, dragging out project times. The construction industry also seems to be suffering from an ongoing shortage of workers, with job openings up from pre-pandemic levels while job openings in the broader economy have fallen significantly. In other words, there are still lots of unfilled construction jobs that, if filled, would promote a sharper rebound in new construction.

Building Permits. New building permits increased 2.1% in June to a 1.241 million annual rate. Compared to a year ago, permits for single-family houses are down 1.1% while permits for multi-family buildings are down 5.3%. Overall, permits rose less than expected in June. However, the reading was held back by a 13.4% decline in permits for multi-unit structures. Meanwhile, permits for single-family homes rose 11.8%. This divergence looks to be an ongoing trend, as builders respond to a shift in consumer preferences for more space in less dense environments due to the pandemic. Based on fundamentals like population growth and scrappage, the US needs to build about 1.5 million new housing units a year, a level that was only briefly reached before the pandemic hit our shores. A continued rebound in construction is likely in the months ahead.

Home Builders Confidence Index. The construction industry’s outlook has continued to improve from its recent lows as buyers rush back into the housing market. The National Association of Home Builders’ monthly confidence index rose 14 points to a reading of 72 in July. Remember, index readings above 50 are a sign of improving confidence, and a figure below that threshold would represent a declining outlook. In April, the index had fallen to its lowest level since June 2012. April was also the first time since 2014 that the index has dropped below 50, and the index stayed below that threshold in May. Builders’ views on the traffic of prospective buyers moved 15 points higher to a reading of 58. Expectations of home sales in the next six months improved by a smaller amount, rising only seven points to a reading of 75. The continued rebound in housing is benefitting home builders — and experts say the rebound is more than just a reflection of pent-up demand. New home demand is improving in lower density markets, including small metro areas, rural markets and large metro exurbs, as people seek out larger homes and anticipate more flexibility for telework in the years ahead. But costs remain something of a concern for home builders. In particular, the cost of lumber has skyrocketed in recent months due to the uptick in demand and a reduction in supply caused by the pandemic. Not only that, but many builders are seeing rising costs of land, and labor expenses remain a concern.

Office Leasing. The pandemic took a huge toll on office leasing in Los Angeles County in the second quarter. Activity plunged 52% compared to the first quarter of 2020. Only 1.9 million square feet of deals for new leases, renewals or lease expansions were signed in L.A. during the second quarter — the smallest amount since the Great Recession. But remember, we’ve got 21% unemployment in our county and tenants reimagining their workspace, which will result in a net negative demand. While those numbers may seem dramatic today, it’s just a small slice of what’s to come. Industry executives expect some companies that are near the expiration date on their leases will renew for shorter periods, while others will wait for greater clarity on their space needs. One bright spot has been downtown where 68% of major lease transactions were located during the second quarter. Downtown has seen heightened interest in recent years because Westside rates pre-crisis were peaking. The gap between downtown rates and Westside rates are at its largest in 25 years. From Pasadena to Playa Vista, nearly 900,000 square feet of new subleases have hit the market since March 15. Of that, 79% are located west of the 101 Freeway. The average size of the spaces available is 21,000 square feet. But, as you know, we are entering a new world. Because of the pandemic, companies will likely downsize in the months ahead or have some employees work from home, changing office size requirements. Many companies could have a 15% to 20% reduction, if not more, in space demands. Look for companies to seek more flexibility with workspace: i.e. the ability to expand and contract quickly.

Industrial Production. The industrial sector continued its recovery, increasing 5.4% in June, the largest monthly gain since 1959. However, that improvement is from a very low baseline. Even with June's impressive headline gain, Q2 as a whole was down at a 42.6% annualized rate versus the Q1 average, the largest quarterly drop since 1946 (during the wind down in the industrial sector after WW2). While there is still a ways to go before a full recovery, the details of the report were healthy. Within manufacturing, auto production surged 105% in June, following a similarly strong gain of 120.1% in May, as car and truck factories continued to resume operations. Expect more large gains in the auto sector in the months ahead, as production in June was still 24.4% below the level reached in February (before the Coronavirus and related shutdowns hit the US). Meanwhile, non-auto manufacturing rose 3.9% in June, its largest monthly gain on record! While some sectors of the economy, like restaurants, bars, and hotels are still at risk due to re-closures and shutdowns, the factory sector is less at risk, and should keep recovering. Utilities output rose 4.2% in June, as warmer weather drove demand for air conditioning and retail stores around the country continued to reopen.

Los Angeles International Airport (“LAX”). The devastation to the travel industry wrought by the Covid-19 pandemic continued to hold Los Angeles International Airport in its grip in May (June & July are not released yet). Passenger counts dropped more than 90% at LAX compared with May of last year. At LAX in May, 576,000 passengers went through the gates, down 92.4% from the same month in 2019! Domestic traffic was off 90.6% to 510,000, and international traffic was down 97% to 65,000. Still, the numbers reflect some improvement from the lows reached in April when passenger traffic overall was down 96% from April 2019 levels. In perspective, the national average was a drop of about 84% from the same period last year. LAX is worse than the national average because of its large portion of international flights. But in a surprising bit of welcome news, air cargo tonnage was up 5% at LAX compared to last year. After three months of year-over-year drops in air cargo tonnage, things turned around in May as LAX reported 209,000 tons when compared with May 2019. One big reason for this is that LAX has emerged as a central receiving point for personal protective equipment sent from other countries, according to the Los Angeles World Airports, the city agency that runs LAX. Airlines and the federal government began expediting imports of personal protective equipment and other materials into the United States thorough LAX. Some airlines even converted passenger flights into cargo operations. The global coronavirus pandemic continues to drive dramatic changes in cargo and passenger volumes at LAX as Southern Californians remain at home, avoid the airport, and rely on the ecommerce supply chain for many of their household supplies.

Rose Parade. Another Los Angeles tradition bites the dust. The annual Rose Parade has been cancelled for January 1, 2021. The key issue for this 132nd edition was health. For months the tournament association and its 953 volunteers had been grappling with the costs of canceling versus going forward with uncertain plans. But organizers ultimately decided that the coronavirus pandemic has made it impossible to go forward with the annual New Year’s Day tradition. The Rose Parade and Rose Bowl football game, along with the many associated activities in the weeks running up to New Year's Day, are touted as injecting over $200 million into the local economy. The ripple effects are also pretty broad. For the tens of thousands of families planning their annual overnight campouts on Colorado Boulevard to say goodbye to a truly crazy year — they will be canceled as well. After all, there will be no parade to wake up to. Much of the enjoyment of the parade comes from those who crowd the sidewalk, and camp out the night before. But with social distancing in effect, such a scene would have been unlikely, significantly dampening the experience. The Rose Parade has been held every New Year's Day since 1891. It was canceled only in 1942 (three weeks after the Japanese attack on Pearl Harbor) and the wartime years of 1943 and 1945. No decision has been made yet whether the equally traditional Rose Bowl football game will be held.

Lori Loughlin’s Estate. Goodbye Bel-Air. Lori Loughlin and Mossimo Giannulli have sold their multi-million dollar Bel-Air mansion, which they put on the market back in January. The couple, who recently resigned from the exclusive Bel-Air Country Club in the midst of the college admissions scandal, listed the house for $28.65 million in January. Although the exact sale price has not yet been recorded, a real estate source says the property was sold for considerably less. Loughlin, 55, and Giannulli, 57, purchased the home in 2015 for just under $14 million. They used the property as collateral for their $2 million bail for the fraud charges. Despite popular belief, they didn’t sell the estate because they had to. Mossimo is actually an experienced flipper and has read all of my books. He has been buying, refurbishing, renovating, and flipping houses for over 20 years. The 12,000 square-foot mansion includes six bedrooms and nine bathrooms, a large swimming pool, outdoor courtyard, two living rooms, formal dining room and an eat-in chef’s kitchen. A Loughlin source says the couple owns a beach home in Orange County, where they are believed to be staying. On May 22, Loughlin confessed to one count of conspiracy to commit wire and mail fraud, while Giannulli pleaded guilty to one count of conspiracy to commit wire and mail. As for what they are looking for in their next home, that’s simple — privacy.

This Week. Looking ahead, the primary focus this week will continue to be news about medical advances, vaccine developments, plans for reopening the economy, government stimulus programs, and Fed monetary actions. Beyond that, this will be a busy week for real estate data. Existing Home Sales will be released on Wednesday (7/22) and New Home Sales will be released on Friday (7/24). And don’t forget the Weekly Jobless Claims on Thursday (7/23). 

Calendar:
Wednesday, July 22: Existing Home Sales
Thursday, July 23: Weekly Jobless Claims
Friday, July 24: New Home Sales

Weekly Change:
10-year Treasury: fell 0.02%
Dow Jones: rose 600 points
NASDAQ: fell 200 points