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Forecast Sees Slow but Steady Recovery


UCLA business forecasters predict sluggish economic growth for the remainder of the year but see no evidence of a second recessionary dip.

Recent data showing flagging consumer confidence and a slowdown in retail spending have heightened nervousness that the recovery will falter. But the quarterly UCLA Anderson Forecast being released today says that barring some unexpected shock, the U.S. and California economies should continue their slow but steady rebound.

"This isn't a particularly strong expansion, but it looks to be sustainable," said Tom Lieser, senior economist with the UCLA Anderson Forecast.

"Interest rates are low. Unemployment is low [compared with the recession in the early 1990s]. We have some pretty good underpinnings at this point," he said.

The forecast says that rapid appreciation in Southern California real estate prices doesn't yet constitute a "bubble," but that Bay Area home values look too high given continued weakness in the tech economy.

In April, median home prices in the Bay Area hit a record $402,000, according to DataQuick Information Systems, even as the region continues to lose jobs.

"Obviously there are a lot of people up there placing a big bet on an early bounce-back in the tech sector," said Edward E. Leamer, director of the UCLA Anderson Forecast. "That's a risky bet ... that I'm not sure will pay off."

After a fast start that saw U.S. gross domestic product advance 5.6% in the first quarter, the economy has shifted to a lower gear.

That's to be expected, UCLA economists said, because much of that early growth was the result of inventory restocking by U.S. firms.

Spooked by the temporary drop in sales after the Sept. 11 attacks, companies fearful of getting stuck with unsold merchandise liquidated goods in their stockrooms at a record pace in the fourth quarter.

But American consumers continued spending, enticed by incentives such as auto makers' interest-free financing deals and low-interest mortgage refinancing that allowed them to take cash out of their homes.

The result was that many companies ran low on inventory and began replenishing in earnest. Speaking at a meeting of business economists this week in downtown Los Angeles, Robert T. Parry, president and chief executive of the Federal Reserve Bank of San Francisco, attributed two-thirds of first-quarter GDP growth to this massive restocking effort, which has provided a welcome, albeit fleeting, lift to the economy.

"Although this turnaround in inventory investment will play out a while longer, it will only boost growth temporarily," Parry said. "We're now in the midst of a modest expansion ... [but] to keep the expansion going, we'll need to see business pick up their spending on equipment and software."

The good news for recession-battered Northern California is that signs are emerging of an increase in business investment. Global sales of semiconductors improved considerably in March and April, and U.S. industrial production figures released last week show solid gains in output of computers and chips.

However, that has yet to translate into job growth in the Bay Area, which has lost more than 140,000 jobs since the employment peak of January 2001, Lieser said.

Even Southern California, which never fell into recession as measured by employment, has seen its job creation weaken substantially.

On balance, the California economy has created a mere 2,500 net new payroll jobs this year as employers under pressure to produce profits and cautious about the strength of the recovery have held off hiring. Lieser is projecting nonfarm payroll employment to increase by 0.2% statewide in 2002.

He expects that sluggish job growth, coupled with a growing labor force, will result in average unemployment of 6.4% this year, declining to an average of 6.3% next year and 6.1% in 2004. In May, California's jobless rate was 6.3%, down from 6.5% in April.

Weak employment growth probably will translate into anemic taxable sales gains as well. The UCLA forecast projects taxable sales in California to increase 0.4% in 2002, rebounding strongly to 5.2% in 2003 and 5.9% in 2004 as the jobs picture improves.

As the overall economy lurches unevenly toward recovery, one sector has bounded steadily upward--residential real estate.

Median home prices, particularly in Southern California, have inflated so rapidly of late that some are wondering if the bubble is set to burst.

The short answer is "probably" for Northern California and "not yet" for the Southland, said Leamer, who nevertheless cautions that Southern California cannot indefinitely sustain the furious price appreciation seen over the last year.

Leamer said that just as a stock's price ultimately must be linked to a company's earnings, a home's price is related to the amount of rent it could command in the open market.

Examining home price and rental data for San Francisco and Los Angeles, Leamer has calculated that the so-called price-earnings ratio for San Francisco homes is at an all-time high, whereas L.A.'s is below its 1989 peak.

"We still have some room to run in Southern California," said Leamer, noting that rents continue to climb steadily in the L.A. region.

As for Northern California, Leamer said he is mystified by climbing home values, particularly because rents have fallen sharply in response to the tech downturn. In the first quarter of 2001, rents across the Bay Area fell about 17%, a decline that housing prices ultimately will have to reflect, Leamer said.

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