What Forces are Driving Californias Recovery Mark Vitner, Managing Director & Senior Economist November 13, 2013

Economic Outlook 2 Key Macroeconomic Trends A Cloud of Uncertainty Hangs Over the Economy Unprecedented changes in fiscal and monetary policy have cast a cloud of uncertainty over economic decision making. The persistence of large budget deficits and new regulations regarding healthcare and financial services have effectively raised the hurdle rate that new investment and hiring decisions must clear in order to be enacted Economic growth continues to gradually gain momentum Californias economy is ahead of the nation in many ways but other areas are more challenged Below Trend GDP Growth Bolsters the Case for the New Normal Real GDP growth has averaged a 2.2 percent pace since the recession ended, which is well below the 3.3 percent pace averaged during the 25 years prior to the Great Recession. The Obama Administration and Fed have worked to close the output gap and bring GDP growth back to its previous trend. The lack of success bolsters the case for the New Normal. QE Has Boosted Asset Prices But Not Underlying Fundamentals The Feds massive expansion of its balance sheet did a good job of driving interest rates lower and sending the stock market higher. While producing some beneficial effects, higher asset prices have done little to boost income growth. QE has also led to increased speculative activity, with home prices rising even when homeownership is declining. Californias Recovery is Broadening and Gaining Momentum Led by strong gains in technology and tourism, Californias recovery has steadily gained momentum. Job growth has decelerated recently and is just keeping pace with the nation. The unemployment rate is trending lower. The gap between the conditions along the coast and the states interior has widened, as the recovery in the Central Valley remains slow. California Maintains a Huge Lead in Technology While competition from Texas and Silicon Alley has received a great deal of attention, Californias lead in information technology has widened in recent years. The Bay area remains the innovation hub for mobile devices social media, cloud computing and alternative energy. Manufacturing remains a huge challenge for the state, however, even with tech.

Economic Outlook 3 U.S. GDP We see economic growth gradually regaining momentum as the housing recovery takes hold and the drag from fiscal belt tightening gradually wanes Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

Economic Outlook 44 U.S. GDP The combination of sluggish economic growth and low inflation means that revenue growth is unusually sluggish, which impacts certain parts of the economy differently Source: U.S. Department of Commerce and Wells Fargo Securities, LLC Nominal GDPReal GDP

Economic Outlook 5 Labor Market Dynamics The employment-population rate hasnt improved over the past four years, despite the fall in the unemployment rate, suggesting that many job seekers have simply given up. Source: U.S. Department of Labor and Wells Fargo Securities, LLC

Economic Outlook 66 Housing Market Metrics Despite some recent setbacks, we continue to look for a gradual recovery in homebuilding. Apartments are playing a larger role than in previous building cycles. Source: NAR, U.S. Department of Commerce and Wells Fargo Securities, LLC Home PricesHousing Starts

Economic Outlook 77 Labor Market Metrics Layoffs have clearly declined but businesses are still reluctant to add staff Source: U.S. Department of Labor and Wells Fargo Securities, LLC HiringInitial Claims

Economic Outlook 8 Negative Equity Mortgages The rise in home prices has helped bring down the share of owners who own more on their home than their home is worth Source: CoreLogic and Wells Fargo Securities, LLC

Economic Outlook Percent change in real GDP by state ID 0.4 AR 1.3 AL 1.2 ME 0.5 KS 1.4 SD 0.2 OH 2.2 WI 3.5 AZ 2.6 NH 0.5 MT 2.1 MS 2.4 OK 2.1 NV 1.5 IL 1.9 GA 2.1 FL 2.4 CO 2.1 CA 3.5 NE 1.5 MO 2.0 UT 3.4 NM 0.2 WA 3.6 IA 2.4 MI 2.2 LA 1.5 VA 1.1 TX 4.8 PA 1.7 IN 3.3 NC 2.7 MN 3.5 KY 1.4 VT 1.2 TN 3.3 OR 3.9 NY 1.3 WV 3.3 ND 13.4 SC 2.7 WY 3.3 AK 1.1 CT -0.1 DE 0.2 HI 1.6 MA 2.2 MD 2.4 NJ 1.3 RI 1.4 DC 0.7 U.S. = – – – – –1.5

California

Economic Outlook 11 California Employment Picture The most recent recession was more than twice as severe as the one California experience following the end of the Cold War Nonfarm employment remains 3.6 percent below its previous peak in California Source: U.S. Department of Labor and Wells Fargo Securities, LLC

Economic Outlook 12 California – Labor Market While nonfarm employment growth has decelerated recently, we suspect that job growth is being understated and look for the unemployment rate to trend lower. Source: U.S. Department of Labor and Wells Fargo Securities, LLC Unemployment & Labor ForceEmployment

Economic Outlook 13 California Nonfarm Employment Growth by Industry Source: US Department of Labor and Wells Fargo Securities, LLC

Economic Outlook 14 Unemployment Rate by County California Source: US Department of Labor and Wells Fargo Securities, LLC California Unemployment Rate August 2013 Less than 8.0% Greater than 14.0% 10.0% to 12.0% 12.0% to 14.0% 8.0% to 10.0%

Economic Outlook 15 California Nonfarm Employment Growth Source: US Department of Labor and Wells Fargo Securities, LLC

Economic Outlook 16 California High-Tech Employment High-tech employment, particularly in data processing, internet, software and computer design, has seen stronger growth than the state overall Recent research by Enrico Moretti suggests that each technology job creates five additional jobs Source: U.S. Department of Laborand Wells Fargo Securities, LLC

Economic Outlook California Per Capita Income High incomes will help boost local consumer spending Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

Economic Outlook 18 California – Home Prices & Construction With home prices improving, residential construction is gradually regaining strength Source: CoreLogic, U.S. Department of Commerce and Wells Fargo Securities, LLC Housing PermitsHome Prices

Economic Outlook 19 California – Home Prices & Construction With the rapid rise in home prices and slight rise in mortgage rates earlier this year, housing affordability has declined. Source: FHFA, CAR and Wells Fargo Securities, LLC Housing AffordabilityMortgage Rates

Economic Outlook 20 Negative Equity by MSA Many coastal areas now have a relatively low share of negative equity mortgages outstanding, while inland areas have taken longer to recover Source: CoreLogic and Wells Fargo Securities, LLC

Economic Outlook Investor Purchases Investor purchases have helped drive up prices Source: CoreLogic and Wells Fargo Securities, LLC

Economic Outlook 22 California – Apartments Apartment development has picked up, particularly in the Bay Area, which has helped stem the slide in vacancy rates Source: Reis, Inc. and Wells Fargo Securities, LLC Los AngelesSan Francisco

Economic Outlook 23 China Slowdown Investor Home Buying Credit Availability & Financial Reform Manufacturing Competitiveness Deleveraging Monetary/Fiscal Policy Uncertainty Immigration Reform Energy/Commodity Price Swings Issues to Watch

Economic Outlook 24 Housing Forecast

Economic Outlook 25 Our Forecast

Appendix

Economic Outlook 27 Recent Special Commentary Wells Fargo Economics Group Publications To view any of our past research please visit: economics To join any of our research distribution lists please visit: economics A Sampling of Our Recent Special, Regional & Industry Commentary

Economic Outlook Wells Fargo Securities, LLC Economics Group 28 John E. Silvia … … Global Head of Research and Economics Diane Schumaker-Krieg ………………… …… Global Head of Research & Economics Chief Economist Mark Vitner, Senior Economist……………....………... Jay H. Bryson, Global Economist …………………....………. Sam Bullard, Senior Nick Bennenbroek, Currency Eugenio J. Alemán, Senior Economist………………. Anika R. Khan, Senior Economist …. Senior Economists Zachary Griffiths, Economic Analyst Sara Silverman, Economic Analyst Mackenzie Miller, Economic Analyst Blaire Zachary, Economic Analyst Economists Azhar Iqbal, Tim Quinlan, Economist Michael A. Brown, Economist ………………… Sarah Watt, Economist ……………………………. Michael T. Wolf, Economist ……………………. Economic Analysts Administrative Assistants Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. (WFS) is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. (WFBNA) is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. WFS and WFBNA are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company © 2013 Wells Fargo Securities, LLC. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited (WFSIL). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, not will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the Materials) are provided for general informational purposes only. Peg Gavin, Executive Assistant. Cyndi Burris, Senior Administrative Assistant