We might already be in a recession

Medical Economics Journal, Medical Economics June 2022 edition, Volume 99, Issue 06

Something very interesting is happening right now: People are pulling back their spending. Retail sales are generally based on dollar figures for spending, whereas consumers tend to frame decisions more in terms of experiences like “should I go out to eat tonight or eat in?” And if you look — at least here in Dallas-Fort Worth — people are pulling back on these decisions. The price of gasoline is way up, median wages are lagging price increases, the stimulus has run its course and the one-way train of profiting from stocks and cryptocurrency has reversed. Restaurants that were packed last year are much less busy on weeknights and road traffic is slowing.

I was 13 when the crash happened in 2008 and I noticed many of the same things. It was almost eerie, but not quite as much as driving around in March 2020.

Looking around is an underrated way of gaining insight into the world. This strategy is much more effective outside of Manhattan, where so much of the financial industry is concentrated. Even going to a couple of Apple (AAPL) stores at different times and talking to people can provide great insight. Apple stores were extremely busy for years when the PE multiple was low, an obvious contradiction that resolved in favor of shareholders in the long run (by the way, I would not say the local Apple stores are very busy right now; if they are getting growth, it will have to be from digital services). Apple reports after the bell for those looking to place their bets. Amazon (AMZN) reports as well, giving a real-time window into the health of the consumer.

So we get the gross domestic product (GDP) report, and it shows a -1.4% annualized decrease in real GDP for the first quarter of 2022. GDP estimates are notorious for revisions, so we get a revised estimate in about a month. But this is kind of a big deal. Two quarters of negative GDP growth is the definition of a recession, so one more figure that comes in negative officially puts us in a recession. Given that we had
$1.9 trillion in stimulus last year and nothing this year, I think our year-over-year comparisons will be hard to beat going forward as well.


Is stimulus to blame?

Many technicalities and offsetting
factors make the official GDP report hard to parse. For example, the dollar is strong and supply is constrained at home, so Americans are importing more things. This affects GDP negatively but is not a big deal. What might be a big deal is whether companies were induced to overinvest and overorder inventory by looking at the huge demand from stimulus last year and assuming it would last.

Restoration Hardware (RH) makes cool furniture, but its recent earnings report was a shock to the downside as consumers cut their discretionary purchases after the stimulus ran out. Freight Waves, a popular transportation industry publication, came out with a forecast for a freight recession a few days after.

The current state of housing also is an enigma to rational observers. The housing market at least felt balanced in 2019 and luxury homes were frankly hard to sell in many markets. Obviously, the pandemic set off a huge housing boom, but the underlying demographics create an interesting contradiction. By year-end, we will have built about 5 million homes since the start of the pandemic, but the U.S. population is only expected to have increased by 1.5 million or so since then. Maybe the net number of new homes is lower because of the roughly 200,000 to 300,000 teardowns of homes that happen in the U.S. per year — but with 2.5 people per household, the implication is that long-term fundamentals only justify about a million homes being built, whereas we are building five times as many.

These numbers are ballpark estimates, but by this lens the housing boom looks like more of a speculative frenzy exacerbated by pandemic-era policies and less of a demographic megatrend. If letting millions of people live rent free for 12 to 18 months and using the Fed to fix mortgage rates below 3% for the same period created an epic short-term housing squeeze, the implication from the true demographic demand is that we might be in for a bust going forward. When the government fixes the price of something too low, a shortage will inevitably result. But when the government stops fixing the prices as a return to normal, this will put people out of business who created business models around the fixed prices, as we saw in the savings and loan crisis in the 1980s and in the 2000s housing bust. Look at homebuilder stocks for what I mean — they are crashing while the housing market booms.

I seem to always pick on housing, but it is one of the sectors where the government has the most influence on economics — unlike the used car market where a boom-and-bust is just an annoyance, or the oil market where such things are common, expected and planned for.

One wonders whether companies of all kinds obtained too much inventory based on what people were spending in 2021 and will be stuck with surplus now that consumers are tapped out. One also wonders whether some of these companies hired too many workers based on the same assumptions and will need to let some go to balance the new supply-and-demand picture.

Nonfarm payroll numbers are still good

We are almost to the payroll peak hit in 2019, and I think we can count on at least a couple more months of good numbers. We are still getting over the shock from the pandemic — the friction in the labor markets means it takes time for workers to come back and be placed in jobs for which they are a good fit.

A question to ask is whether we have too few people working, about the right amount or too many. The mainstream answer is that we have a labor shortage, but companies have been remarkably flexible in dealing with this. (Have you used self-checkout lately?) Although I agree that there are still some shortages in the service industry, I think we might have too many people working in certain sectors of the economy — construction might be a prime candidate for a bust in 12 months.

The labor market is continuing to normalize, but as part of the process my guess is that rapid gains in nonfarm payrolls will turn to mild losses in the back half of this year. The Fed is in a tricky spot here if inflation stays high and the jobless rate starts to inch higher, but my guess is that as long as unemployment is below 5.5% to 6%, then getting inflation down will be more important.

The worst thing the government could do here is to print lots more money and start the cycle over, but I think they learned their lesson from the mistakes of the 1970s. Populism and the desire to attempt to print to prosperity seem to be on their way out — France and Slovenia just chose centrist candidates rather than populist ones, and inflation is arguably the No. 1 political issue in the upcoming U.S. midterms. The government did not rush to bail people out in 2008 the way it did in 2020, reminding traders that the “Fed put” is not universal.

Takeaways for Your portfolio

The market is forward looking, whereas economic data is backward looking. Looking around into the world can help bridge the gap. What I am writing about here is a big part of the reason the S&P 500 is down about 12% for the year. My guess is that we have 10% to 20% more downside from here, making this market worse than in the early 1990s but better than in 2008. Valuations now never got quite as crazy as they did in the late 1990s, but we could see a market with some of the same mechanics of the tech bust of the early 2000s.

The future is uncertain and long-term investors do not necessarily need to sell to sidestep this, but I think you will be able to get stocks cheaper in six months than you can now. At the very least, I would try to make sure you own as much as possible of quality companies with real earnings and not speculative companies or companies with junk-rated credit. Consumer discretionary stocks and high-valuation companies are the riskiest right now, so avoid those if possible. Good luck to all.