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- The broader economy is now slowing down
- How U.S. companies are holding up so far
- Wages are still high but upward demand is decelerating
- China’s lockdowns are affecting their GDP capacity
The broader economy is now slowing down.
The Conference Board is a membership of industry and finance experts from all parts of the economy who gather to assess and make policy recommendations based on the current economic climate, and they regularly produce and update several of their own economic reports for the public. One of the most respected from this organization is the Leading Economic Index or LEI (the dark blue line below). This is a forward-looking view of where the Conference Board projects the economy approximately one year from now based on real-time economic activity today, and the trajectory of that activity.
The graph below overlays this assessment with the actual reported US Industrial Production (the light blue line), and we can see that although the indicators are usually aligned very closely, and always trend in the same direction, the LEI sometimes over-estimates at the absolute tops and bottoms of the market cycles. But the trend has never been a “miss” since the indicator started in the 1950s.
The Conference Board’s LEI is again in negative territory, the first time since Covid, indicating that the economy is trending toward a recession in 2023. We don’t know exactly how deep or how prolonged this recession will be, but nearly every leading economic index is now pointing to recession in the next 3 to 12 months.
Some of the industry data comes from regional Federal Reserve Banks around the country, and they stagger their reporting of economic activity throughout the month. Last week the Richmond, Virginia Fed reported on manufacturing in that bank’s region, and it confirms that economic slowdown is underway, at least in the Richmond Fed’s trade area:
The Richmond Fed also reported, for the first time since Covid, a slight reduction in the workforce in the region:
This makes sense considering the fact that factory capacity in the region has also declined. This indicator shows that factories have excess capacity (are not operating at full capacity), which tells us factory orders, at least for companies in this region, are slowing down:
At nVest Advisors, we concur with the broad opinion of recession in our economy in 2023 (and a much more significant recession in Europe and Asia). However, our belief is that the coming recession will be deeper and last longer than the current majority consensus, and we are adjusting our investment models for that worst-case scenario, as we have been since January of this year.
How are U.S. companies holding up so far?
There is no absolute definition for what a recession is, but the general consensus among economists is that we need to have two consecutive quarters of negative GDP (collective economic output). We’ve already experienced that in the U.S. this year, but a recession did not officially get called because there was still so much demand for labor (meaning companies were still trying to expand), and there was still strong upward pressure on wages.
Again, this makes sense: if we are in an economy where multiple companies are competing for every worker, the demand for that worker will push up the wages and benefits offered (which will drive up operating costs, which will drive up the final prices of the products and services produced by those companies). It is this wage/price “spiral” that is causing the continued upward pressure on prices in our economy.
In order to fix the sky-high prices of goods and services, the Federal Reserve has to “break” the demand for workers. Instead of five companies competing for every worker, they need five workers to be competing for every job. The way to do that is to force the economy into a recession.
So we will look to company profit numbers to see how production is holding up, and if there appears to be pressure on the company to cut costs in the face of declining sales and revenue. Sadly, we need to see hours cut and jobs lost before we may be out of the worst of this inflationary spiral.
So far, how a company is holding up depends greatly on how big they were to start with. This chart shows operating margins (the profit) of the U.S. publicly-traded companies, broken up by size:
As would make perfect sense, the largest companies have the most room to maneuver during a recession, where the smallest are seeing the lowest margins (and dropping the fastest). This is one of the reasons why investors seeking safer bets during economic uncertainty will generally shift toward larger, more profitable companies (we call them “large capitalization” or “large cap” or “blue chip” stocks).
Also, the current earnings per share of common stock of the S&P 500 companies, so far, has held up okay. This is one way we know that, while a recession is imminent, we are not likely in one yet.
Another good “tell” that we are headed toward recession is when you survey the CEOs of major companies and ask them what their views are of the economy and their company’s prospects for the year ahead. The dark blue line is what CEOs are telling us of the future expectations for their companies, overlaid with the official projected earnings per share that the same companies have given to their investors (the red line).
Sentiment is an important indicator because even though it is an emotional and “gut” reading, sentiment tends to become a self-fulfilling prophecy. When we feel optimistic about our prospects, we will generally take more risks: expand to a new market, open a new factory, and hire more employees. But when the opposite is true, we tend to tighten the budgets, reduce spending, pull back on expansion plans, etc.
Wage pressure is still very high but starting to moderate
One of the key factors in how high the Federal Reserve will have to raise interest rates, and for how long, is the market’s pressure for more and more workers, and workers’ demand for higher and higher wages. They watch job numbers very closely, and we get new jobless claim figures once per week.
Currently, demand on wages appears to be moderating slightly, but there is still significant upward pressure on wages (understandably so from the workers’ perspective – prices on just about everything has skyrocketed over the last two and a half years).
However, we are starting to see that, while initial jobless claims are still historically low, the number of reported layoffs is starting to tick up slightly. The reason this hasn’t changed jobless numbers yet is that there are still so many available jobs in the economy.
This is one of the major reasons the Federal Reserve hasn’t yet declared a recession in the US, and one reason we believe the economy will get much worse from here before our central bank can change course.
And so far, while the current jobs openings are tending down slightly, they are still significantly above the current actual number of workers in the U.S. We believe this number will drop dramatically in the coming months, but so far, companies are still hiring, which means, no end to increased prices in the short-term.
However, we may be nearing a top of that cycle, finally. There is still significant demand for more workers, but the upward pressure on wages appears to have peaked, at least for now:
This “sticky” demand for more employees at higher wages will mean that the Federal Reserve’s job in reducing the money supply (called “quantitative tightening”) is not finished yet. Many other economics and financial analysts are beginning to conclude the same thing we are: that the Federal Reserve will have to raise rates higher than originally projected, and leave them there for significantly longer than many on Wall Street want, in order to finally bring wages and prices back down.
The recent rally in the stock market has largely occurred because traders on Wall Street are second-guessing the Fed’s resolve on combatting inflation. Many investors think the Fed will flinch; that it will “pivot” on its current policies, and begin to lower rates fairly soon. We think that is not only unlikely given the constant demand for employees and the still upward pressure on many prices, but utterly foolish to bet that the Federal Reserve cares more about the current trading level of the Dow Jones or the S&P 500, and less about the long-term economic stability of the United States.
China’s Covid lockdowns are significantly impacting their GDP.
China has been one of the world’s more draconian nations on dealing with Covid outbreaks. Originally declaring an end to their “Zero-Covid” policy earlier this year, the world’s second-largest economy has reversed course and is again locking down major cities as their Covid cases spike significantly:
The current lockdowns, including Shanghai and several other major centers of industry, mean that China’s Zero-Covid policies have now shuttered or severely restricted approximately 60% of its GDP. We continue to monitor the economic impact of these and other geopolitical events.
A quick look at major changes in commodities.
And finally, just a quick look at some of the commodities that affect the broader economy.
Oil prices have dropped as supply has increased, particularly in Europe. Diesel remains strongly elevated, affecting the prices of retail goods and transportation generally:
We do not believe oil supply problems have been fixed, and oil will likely climb again in the coming months. There appears to be a growing consensus that our projection is likely to be correct:
Housing price inflation appears to be moderating slightly, as rent inflation appears to be moderating. Note that this doesn’t mean rent prices are dropping; just that the rate of increase is slowing.
And finally, a quick look at the cost of imports. For several months, the U.S. dollar has been historically strong relative to other world currencies. This has the biggest effect in the import / export markets: before you can buy a product in another country, you first need to swap to their currency. When the dollar is strong against, for example, the Japanese yen, someone in the U.S. buying a Japanese product will first swap their dollars for yen, and then make the purchase. When the dollar is very strong, it will “buy” many more yen.
The net effect of this currency exchange rate over the last year has been that products made in the U.S. became more expensive for other nations to buy, and products overseas became less expensive for us in the U.S. As a result, imports to the United States would likely increase, while exports from our companies to overseas buyers would decrease.
As the dollar has dropped in value over the last few months, we are starting to import prices climb back toward parity. We still import much more than we export, but the trend is helpful for U.S. companies who compete against international companies in the U.S. market.
Although the U.S. economy is holding up better than much of the rest of the world – for now – the storm is most definitely gathering. We firmly believe that the economy will continue to erode and sadly, we will all feel some amount of the financial squeeze that is not only inevitable but frustratingly, necessary to fix the overwhelming supply of money that was dropped into the world economies during the Covid-19 shutdowns. 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.
Use these economic reports to prepare. 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. If you need help with this, nVest Advisors has amazingly affordable personal financial planning services to help you.
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