Forecast and Conclusions

The background for this California Report has been the forecast that we’ve maintained throughout 2006 – slowing housing markets will create a significant slowdown in the California economy, but will not create a recession without a secondary source of weakness.  We’ve presented two candidates for potential sources of weakness (a negative wealth effect and a budget crunch), and two candidates for sectors that could soften our landing with accelerating growth (Professional/Business Services and Leisure/Hospitality).

In the end, none of these alternative scenarios look likely enough to cause us to alter our basic forecast.  Currently, we don’t have enough evidence to believe that the wealth effect will be big enough to dramatically alter the path of the California economy.  A budget-related shock from Sacramento looks almost unavoidable, but with a significant portion of the projected shortfalls coming from discretionary pre-payment of debt, there may be some room to maneuver on the timing of this crunch.  On the other side, neither of our candidates for savior sectors looks poised to generate enough growth to pick up the slack left by weakness in Construction and other housing sectors.

Thus, the central message of our forecast remains unchanged.  The construction sector will continue to weaken, with total residential permit activity and construction employment hitting bottom in late 2007.  This weakness will slow the California economy, but without a second source of weakness, it will not be enough to create a recession.  Overall growth in non-farm payrolls will slow to 0.5%, with unemployment ticking up to 5.2% by the end of 2007; similarly, growth in real personal income and taxable sales will slow to 1.5%.  2008 will see a small recovery, but will still remain sluggish.