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On the One Hand... and on the Other


Standing on the threshold of 1999, economists seem to be in a muddle. Last year, the forecast was easy. After five years of gloomy recession, the sun had broken through. There were huzzahs and hallelujahs. Oh, yes, the Asian flu posed a bit of worry. But it was so good to see the value of San Diego homes going up again. People who’d been sitting on their properties since 1990 called their brokers for new estimates. It was a joy to see folks returning to San Diego who’d left for work in Arizona or Nevada. The stock market was looking up. 1998 would be a good year.

And so it was. But going into 1999, the word was no longer “hallelujah.” It’s “cautious optimism.” It’s “on the one hand.” It’s “wait and see.” Avoid high-risk investments, financial advisors warn. Be alert to sudden global changes. Things happen quickly—literally overnight. Is it a good time to start a new business? To put your house on the market? To switch your 401(k) stocks to bonds or money market?

Fueling this uncertainty, unsettling events did happen. The flu spread from Korea to a string of other Asian countries. Currencies collapsed. The Japanese Nikkei hovered near its lowest level in many years. Even Hong Kong showed weakness. From the highs set last July 17, the U.S. stock market in October dropped just over 19 percent, close to the often-cited threshold of a 20 percent decline that defines a bear market. The switch to low-risk investments became so dramatic, interest on Treasury bills went south of 5 percent.

Russia tanked completely. South America began to look sickly. Brazil needed a sudden infusion of $42 billion from the International Monetary Fund (IMF). We almost went to war with Iraq. Whoops! What was happening?

Then in November, after the IMF made a sizable loan available to Brazil, things turned rosy again. Our stock market recovered to challenge its former highs, springing once again over 9,000. Business groups congratulated each other on a recession narrowly missed.

Even in San Diego, where conservative opinions usually prevail, the San Diego Chamber of Commerce released happy graphs showing a history of growth. Real estate is in a boom mode, says research director Kelly Cunningham. The recent election showed a definite pro-development bias. The education-bonds bill passed, promising $1.5 billion to the schools. The Padres ballpark was approved, preparing the way for growth in downtown’s East Village.

The county’s population will hit 3 million by the year 2000, says Cunningham. More than a million people are currently working in San Diego County (even though the average salary is only $28,845). Exports to Asia, although cut radically because of general economic bedlam in Japan, Indonesia and neighboring countries, account for only a small part of our area’s economic growth—and we still have Mexico and Canada. The Navy’s SPAWAR program has brought 4,500-6,500 jobs to San Diego during the past few years. We have diversified away from defense, converting high-tech metals to such consumer products as golf clubs. An ironic footnote: Saturation of the golf-club market drove Callaway Golf to lose half its market value and lay off 700 employees.

But the list of blessings goes on: Our biotech and biomedical companies employ 22,000. We now have two Fortune 500 companies headquartered here—Sempra Energy (the old SDG&E) and the high-tech newcomer on the block, Gateway. How could life get any better?

Well, says Alan Gin, economist for the University of San Diego, here’s a different perspective. In September, for the first time since March 1995, his USD Index of Leading Economic Indicators for San Diego County fell 0.4. A sharp drop in local stock prices fueled the downward move. Going into the year, local stocks were down 35 percent. By fall, they were down 50 percent. (They had recovered in late November to minus 40 percent—still not a reassuring figure.)

Gin noticed declines in his Consumer Confidence Indicator for both September and October, paralleling a national trend, and in help-wanted advertising (based on ads in The San Diego Union-Tribune). Companies seemed to be scaling back and not filling vacant jobs. It’s true that building permits were up, and construction, while a long way from the late ’80s, was better than in the early ’90s. But the trick, says Gin, is for rest of the economy to keep pace with construction. Any future change in the national economy could adversely affect San Diego, especially in tourism.

The negative Consumer Confidence figures worried Gin because consumer spending is a huge part of the San Diego economy. While national consumer confidence turned positive in November, no local figures are available yet. Retail analysts have been predicting a sales gain of 4.5 to 6 percent during the holidays, compared to Christmas 1997.

What does all this mean?

“I’m not saying a recession in San Diego is imminent,” says Gin. “The index has been positive for a long time, and this is just a one-month change. Usually we look at the economy over a three-month period. Back in May and June, the national indicators were down, but July didn’t confirm this drop, and we were flat in August. But the first down month should serve as a warning: We may have potential problems.”

Michael Darby, UCLA economics professor and consulting economist for City National Bank, acknowledges the difficulties—the Russian default, the rush to safety that sent treasury yields down, the crisis in Brazil—but credits the world central banks with taking quick action to avoid global financial catastrophe. And he applauds the Federal Reserve for lowering U.S. interest rates twice in October and once in November.

Yet Darby wonders if we can remain an island of prosperity with Asia declining. He sees a rise in inflation of 2.5 to 3 percent for the United States in 1999, but insists it will be another good year for California. Not as good as ’98—there will be slower growth, but still good. We can’t expect the same meteoric rise in stock market values, Darby says, but we can be satisfied with 7 to 10 percent growth in the stock market. Unemployment should be stable at 4.5 to 5 percent.

Many economists believe an element of hysteria has overshadowed our domestic equity markets. They acknowledge turmoil in Asia, Russia and Latin America, but believe these factors will result in a slowing in the growth rate of the U.S. economy rather than pushing us into recession. Higher levels of volatility, yes, as well as more moderate returns. But no recession.

Bud Leedom, stock analyst whose San Diego Stock Reports newsletter covers 130 locally based companies, says small San Diego businesses heading into 1999 will have a tough time. “The small companies can’t diversify out of risk,” Leedom says. “Qualcomm is holding its own very well because, while it has exposure in Korea, it’s also in many other places in the world. We have the ingredients here for a recession, but the numbers have not borne that out.”

How do these predictions affect the average San Diego homeowner—or prospective homeowner? Patricia Moore, owner of Insight Mortgage Services, reports a sudden lull in mortgage applications.

“As long as we have an investment world with a high-security bias,” she says, “we won’t have a vital first-time-buyer market. We wouldn’t have had the kind of sales volume we did had it not been for the new loans that allowed people with a few unsightly blemishes in their credit records to qualify for loans: people with minimal cash for down payment, people who needed even more than the market value of the home they were buying to make the deal work—125 percent loan-to-value mortgages. We had the healthiest first-time-buyer marketplace in history.

“Those mortgages and extremely low interest rates—and a big dose of rosy optimism about the economic future—got us a real estate boom that took us all by surprise,” Moore says. “That was in the first quarter of 1998 and the early second quarter. But mortgage applications have dropped off significantly since September.”

Her guess is that when people saw their 401(k)s drop in value, it changed their feeling of net worth. “The slowing happened abruptly,” she says, “and hasn’t yet picked up.”

But while mortgage applications haven’t picked up, construction employment is at an all-time high. Only three months in 1989 surpassed current levels. With a large shortage of residential housing, as well as a number of infrastructure projects before us, local building industry experts don’t think Southern California’s current building boom has peaked.

Robert Horsman, president and CEO of San Diego National Bank, says he has deals in the pipeline approaching $300 million —even more activity than last year. “During the recession, people got their mapping, their subdividing done. Once they saw the economy recovering, they pushed the paperwork through. What we see here is people waiting for the ‘good economy window’ to open.”

Many of Horsman’s loans are focused on large single-family tracts in East and North County—in El Cajon, Alpine, Valley Center. He has a $6 million spec office building going up in Carlsbad, near Legoland. A downtown Hilton Hotel, across from the Convention Center expansion, has been approved at $33 million. With the passage of Proposition C opening the way to development around the new ballpark, he expects “enough momentum to take us through the millennium.” And Horsman boasts of still more money to loan. “I can lend up to $50 million to any one borrower,” he says.

But Horsman also senses an atmosphere of caution. Much of the loan demand he is experiencing comes from conduit lenders who bundled loans to take to Wall Street, then found investors cooling on the deals. A flight to quality sent Wall Street money into the safety of U.S. Treasuries.

“When those deals failed, we got some of them back,” says Horsman. “So the psychology has changed a couple of points toward caution. There’s a little more caution than a year ago—but still a lot of opportunity and properties to develop.”

One bright note: Almost nobody expects really bad news about the San Diego economy during the first two quarters of 1999. The second half of the year? Well, that’s anybody’s guess.
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