At nVest Advisors, we believe that successful investing depends on an understanding of, and correct response to, changes in the world economy as they happen. We incorporate real-world economic conditions into almost all of our investment models and strategies at nVest Advisors, which we believe provides significant benefit to our clients’ overall investment returns. For more information about our investment philosophies and management style, click here. To be receive these economic updates via email when they are published, free of charge, please subscribe here.
- Layoff announcements are accelerating
- Is inflation actually slowing?
- Crypto concerns accelerate
- Housing market continues to cool down
- Businesses are preparing for recession
Layoff announcements are accelerating.
One of the strongest indicators of coming economic conditions tends to be both consumer and producer sentiment. There is no better way to determine how business conditions are than to ask business owners, and the same is true for consumer spending. Sentiment matters because consumers and businesses are making decisions about their spending now in anticipation of what they see coming in the months ahead. Because of that, sentiment tends to become a self-fulfilling prophecy: if we feel insecure about our finances in the coming months, we will rationally take steps to reduce our costs and “batten down the hatches” until the economic storm passes. What this means for consumers is that we may put off making major purchases or changing our living conditions, and businesses may reduce costs, delay hiring, or even lay off workers. They will certainly not expand their factory capacity, or move into new markets if they expect conditions to worsen.
The University of Michigan conducts surveys of both households and businesses, to get a sense of their confidence (or lack thereof) in the current economic environment. Numbers released this month show that consumer confidence is extremely low overall (Chart 1), as well as when the data broken up in terms of our current financial conditions (Chart 2), as well as our expectations for the coming months (Chart 3). (It would be a potentially positive indicator if the current conditions were poor but there was optimism for the year ahead, but in this case, sentiment over both current and future outlooks is poor.)
This is also showing up in business confidence surveys. This chart shows overall business sentiment one year from now. In short, business confidence about the next year is as low as it was during the Great Financial Crisis and Recession of 2008-2009:
This is translating into businesses announcing hiring freezes and layoffs at an accelerating pace. The expectation of layoffs is growing (the lower the number here, the less confident people are in their job security).
We believe there will be a significant weakening in the labor markets in the coming months as a recession fully grips the U.S. economy. This is partially intentional; the Federal Reserve’s attack on inflation requires the upward pressure on wages and prices to be reversed, and sadly, that means that instead of five companies competing for every available worker, there need to be five workers competing for every available job. Hiring freezes and layoffs are, sadly, part of this inflation reduction process.
This begs the next question (and subject for review):
Is inflation actually slowing?
One of the toughest challenges for central bankers is trying to determine exactly what is happening with inflation. Some parts of the inflation calculation can be determined fairly quickly, like gasoline prices or a survey of grocery costs, but others, such as housing and health care, drag out much longer before we can clearly see changes in them (rent, for instance, is often a twelve-month contract, so changes in rent don’t show up right away).
There is conflicting information about the actual direction of inflation. While most economists believe we have reached a peak in the current inflationary cycle, at nVest Advisors, we are concerned with two significant forces that work to keep inflation climbing: the value of the dollar, and the current supply of energy.
Presently, the current official inflation rate is 7.7% year-over-year. This is a decline from previous readings, and it does appear that inflation, as generally calculated, has peaked:
However, many people (including us) are not confident that inflationary pressures have truly subsided.
One reason that prices appeared better in the last few months was that the United States dollar was at record highs in terms of its value relative to other world currencies. This “strong dollar” means each dollar was buying more “stuff”, effectively lowering the price (in dollars) of those goods. One of the biggest effects of that “strong dollar” was that buying petroleum from overseas was significantly cheaper all summer. Although oil prices declined sharply last week on the assumption of slowing demand, there are still several major supply problems and many nations need to refill their strategic reserves after depleting them throughout 2022 to attempt to lower energy prices domestically.
That “strong dollar” trend was broken in the last week, so it will begin to take more dollars to buy goods and services again soon, including oil. It is the oil supply problem, partly due to reduced output from a variety of nations, and exacerbated by the Russian/Ukrainian conflict and the resulting trade embargoes against Russia, that is the second reason we do not believe prices have actually peaked yet. Everything in our economy depends on low-cost fuel to power our cargo ships and trains, to refrigerate our products, to power our factories, etc. Oil prices affect the cost of almost every other product and service in the economy, and so climbing oil prices means climbing prices on everything else.
We will continue to watch inflation indicators, but our investment models are currently anticipating inflation to remain high and possibly even climb slightly again, in the coming months.
The “Cryptocalypse” Continues
Cryptocurrencies continued their sharp decline started a year ago last week as the fallout from the failure, and it appears, fraudulent activity, of one of the largest crypto trading platforms, FTX, repeatedly made headlines. For those unfamiliar with FTX or the recent carnage in the crypto space, here is a good summary of events to review.
At nVest Advisors, we’ve never included crypto in any of our client portfolios or models for many of the reasons it is collapsing today: it’s a largely unregulated asset class, there are no ways to verify the holdings claimed by many of the major players (and many flatly refuse to produce any proof of their asset claims), it was rife with fraud, theft and abuse, there is no intrinsic value to these coins (they make nothing, they have no customers, and there are no assets supporting them except the coin itself) and many of the major players in crypto had no previous provable success running any other business.
On a more philosophical level, we were always very leery of the constant hyping and shilling in the crypto space; something that only has value if you can convince another investor to get in after you is the literal definition of a Ponzi scheme. In fact, many actual Ponzi schemes involving crypto have already been uncovered. As such, we stayed away from this asset class until it was regulated and our clients could obtain cryptocurrencies in US-based, SIPC-insured custodial accounts (which is still not possible).
It appears our long-standing concerns were well founded. All cryptocurrencies, including flagship Bitcoin, have suffered enormous losses this year as one coin after another, followed by one crypto company after another have collapsed. And sadly, the speed and size of failures appear to be accelerating. Bitcoin itself is down approximately 77% in the last year.
We urge our clients to remain completely out of the crypto space, whether it is in the coins themselves, in defi, or in stock or other illiquid investments in the companies orbiting this asset class. We do not believe the carnage is done yet, and have no confidence in this asset class as a whole until it can be given proper oversight.
The housing market continues to cool down.
We’ll mention housing a lot in these economic reports for a number of reasons. First, housing is a fundamental human need and is therefore a highly sought and significant part of our lives. Second, a surprising number of other industries rely on a strong housing market to thrive. Also (and hugely important because of the interest rate environment in which we find ourselves), housing is the most sensitive sector of the economy to changes in interest rates. It is a leading indicator of the rest of the economy; where housing is headed, the rest of the economy will soon follow. And housing has totally collapsed:
As we mentioned last week, the housing market in the United States (and in other countries, as well) is essentially in free-fall. More evidence of that was released last week, including existing home sales being significantly lower for this time of year, the lowest read (excluding the brief Covid shut-down in 2020) since 2008.
2008 was the year our last major recession occurred, and housing was a leading indicator then, as well.
The reason for this decline is very easy to understand: home prices ballooned in the last 2.5 years due not so much to increasing demand (though that remains strong), but to the massive infusion of money into our economy from the government spending programs related to Covid-19: in the United States, it was repeated stimulus checks sent to consumers and a massive amount of forgivable business loans (“PPP”). All of that money was printed out of thin air (as opposed to being created through productive industry) and was instantly available in the economy. When you have lots of new dollars chasing the same number of goods and services, including houses, the prices naturally increased.
Adding to this perfect storm of too much money, the Federal Reserve lowered interest rates to 0% for banks and the government to borrow during Covid, and kept those rates artificially low all the way to March of this year. This “Fed Funds Rate” is the basis for the entire spectrum (we call it the “yield curve”) of interest rates for all borrowing in the country, including home mortgages. In 2020, we saw the interest rate for 30-year mortgages drop to almost 2%.
Combine huge sums of “free” money with record-low interest rates, and the average family could afford a MUCH more expensive house than they could before the pandemic.
That is the basis of today’s problem. In response to the inevitable inflation that followed such (in our opinion) foolish “free money” policies of the last few years, the Federal Reserve has now significantly increased the borrowing rates, raising mortgages from approximately 3% in January of 2020, to almost 8% today.
If you combine the high home prices sellers are asking for, with the average rate of a new home loan, houses have now become the least affordable at any time in U.S. history. It now takes an income of over $107,000 to afford the average home in the United States:
We do not believe this is sustainable, and in fact, with the collapse in mortgage applications and new and existing home purchases, it will not be. We see significant declines in the housing market still to come, and as the economy worsens and job losses begin to mount, the addition of foreclosures and “fire sales” will drive home prices down 25-35% from current levels.
This is bad news for a home seller but VERY good news for a family looking to buy a home. We believe you will have a very favorable home price market in the coming 12-24 months, so get ready by reducing your other debts, and build your down payment savings now. If you need help with this, nVest Advisors has amazingly affordable personal financial planning services to help you.
Businesses prepare for a coming recession (you should, too).
Despite media claims that inflation has peaked and is trending down, we believe there will be upward pressure on prices for a while longer, and that means we won’t see relief in our pocketbooks for at least another year. The same holds true for businesses.
Before we pick up a product on the store shelf and take it home with us (at hugely inflated prices this year), that product must be manufactured, stored, shipped, and delivered to the store shelf. All of those costs (called the “producer prices”) continue to be elevated and, in fact, have actually trended UP for the last four months. While still below its June peak, the Producer Price Index reported its second-highest total in more than 40 years in October, and the trend continues to climb:
There are several major components to our country’s economic activity (the measure of which is called GDP, or gross domestic product). More than 70% of the entire GDP of most developed nations is consumer spending; that is, you and I shopping and spending our paychecks. Business investment makes up about 10% more of that GDP, with government spending accounting for another 10% (our exports to other countries make up the rest).
As we discussed last week, the consumers are largely “tapped out” and our personal consumption has dropped significantly. The same is now true for businesses. Companies are seeing declining sales and profit due to our lack of spending, so many are now slowing down their own spending as a result, in preparation for a coming recession. This is what companies are forecasting for their spending in 2023 (a decline in spending of around 2%):
We are constantly preparing our client portfolios for a continued slowing of the global economy over the next 12-24 months, and we believe investors are wise to do the same. Political advisor to President Bill Clinton James Carville famously said, during the 1996 election cycle, that voters always react to what’s happening to them financially, and we strongly agree. “It’s the economy, stupid,” Carville said during a candid interview on CNN. We build our investment models around this crass but simple statement.
There will be lots of speculating in financial media about “soft landings” and “Fed pivots”, but analysts who choose to second-guess economic numbers as they happen, are, in our opinion and to use a tired analogy, staring at the bark of the tree and not seeing the entire forest behind them.
The economy will continue to erode and sadly, we will all feel some amount of the financial squeeze that is inevitable. It’s important to keep your emotions in check and take the steps you can to prepare your business and your family’s finances, including your investment portfolios, for what is coming. We do not post “bad news” to depress you; we post it to prepare you. You can not only avoid much of the pain that is coming, but you might actually profit from it, if your investments are properly positioned, and you’ve done what you can to shore up your business’ and family’s financial situation.
This is what we do for a living, and we’re very happy to partner with you on that endeavor. Reach out to us for a totally free consultation and portfolio audit today if you’re concerned about where your finances sit for the coming few years, particularly if you are at or approaching retirement age. We’re delighted to offer you our thoughts. You can schedule that time with us below:
Watching This Week:
- Retail Sales as we head into the holiday season
- Labor Market Update