State Economy Strengthens in Face of Port, Drought, Domestic Outmigration Challenges

California’s economy continues to power forward, with many of the Golden State’s largest and most important industries gaining momentum over the course of 2014, according to the latest quarterly report​ from the California Chamber of Commerce Economic Advisory Council.

California Economy

Although the council expects California’s economy to continue to grow, the state is not without its challenges. Growth has moderated recently, and the tremendous surge in tech-related hiring and associated construction projects is unlikely to be sustained longer term. Retailers and financial services firms are still posting only modest gains.

Labor disputes at West Coast ports could push importers to make more permanent adjustments to their supply chains away from Los Angeles and Long Beach. Lower oil prices are weighing on the energy producers in Kern County, and a lack of water remains a challenge for farmers and residents alike.

In addition, the state’s high costs of living, combined with sluggish wage and salary growth for middle-income households, has exacerbated the outmigration of residents. Few of these problems are truly new, however, and California seems to continuously prove that none of them are insurmountable.

Read the full report​.

Global and U.S. Economy

While most key economic reports have continued to show strength, commodity prices and the financial markets have clearly felt the sting from the cold winds blowing in from overseas. .

The dollar also has continued to strengthen against most other currencies as investors, businesses and individuals around the world recognize the better risk-reward relationship in holding U.S. assets at this tumultuous time.

The slow start to GDP growth may present new challenges to the Fed. Much of what is slowing in the economy is occurring in capital-intensive industries, which means the hit to GDP is far greater than to employment, which has actually been quite strong in recent months. Productivity growth has also slowed considerably in recent months and will likely get off to a slow start in 2015.

Nevertheless, headline inflation figures have followed oil prices broadly lower. Core inflation has been less impacted, but has still moderated a touch. The Fed remains on course to raise interest rates around the middle of this year, when circumstances surrounding global economic growth and oil prices will likely be much different than they are today.

Facing Headwinds Head On

Ports

So far, the state seems to be weathering its challenges rather gracefully. The ongoing port dispute at the Port of Los Angeles and Port of Long Beach is creating some real hardship for businesses in Southern California. While some of loss figures bandied about may be over the top, the losses for individual businesses are quite meaningful.

In addition, businesses involved with perishables, including seafood and produce, will likely suffer some losses. Moreover, the longer the dispute festers, the more likely that Midwest and Northeast businesses will look to alternative ports, fueling growth at several South Atlantic ports.

Drought

Drought is a major long-term challenge for California. Farmers have suffered as a result, but higher prices of key crops are partially offsetting low yields and farmers are moving toward more water-efficient crops.

In addition, the scarcity of fresh water has spurred investment in much needed infrastructure improvements, including the desalination plant in Carlsbad and numerous smaller water storage and water treatment projects around the state.

Emigration

Another major challenge for the state is that more residents move out of California each year than move in. This domestic outmigration has long been a cause for concern and is frequently blamed on the state’s high housing costs. California does benefit from positive net migration, thanks to net international migration.

Despite high housing costs, relatively few households spend more than 30% of their income on housing. In the San Francisco metro area, 39.9% of households spent 30% or more of their income on housing costs, while that share was 43.4% statewide and 47.5% in Los Angeles. Although these numbers are above the national average, they show there is more flexibility in the housing market than first appears.

Office Market

Holds Strong in Bay Area

The office market in the state continues to flourish. Employment in the construction of nonresidential buildings is up a whopping 9.6% from a year ago.

The office market is tightest in San Francisco where the vacancy rate is just 11.7%, considerably lower than the nation’s 16.7%.

With an office vacancy rate of 17.7%, San Jose has more supply than the markets along the Peninsula. Activity in Silicon Valley, however, is still quite high.

Southern California Softer

Demand for office space in Southern California has been considerably softer.

While more modest than the Bay Area, the creative sector has been vibrant throughout Southern California, particularly companies producing digital entertainment content. Some of that work is beginning to come downtown.

Similarly, San Diego’s office market is holding its own, with very little space currently under construction.

Home Sales Growth Struggles

Home sales improved only modestly in 2014, with the single-family market up just 0.6% over the year, and the condo and townhome market rising a paltry 0.2%. Home sales languished nationwide in 2014, so the weak growth rates actually look quite a bit better when comparing them to national numbers. San Francisco, San Diego and the Inland Empire all saw home sales rise this past year, while Los Angeles, Orange County and much of the Bay Area outside of San Francisco posted declines.

Thanks to the faster-than-average appreciation, home prices are just 15.2% below their prerecession peak, not much further than the national average of 13.4%.

Read the full report.