Our economic updates are written once weekly by nVest Advisors CEO Jeremy Torgerson for the general education of the public, and as a way to provide transparency for our clients and sponsored-plan participants as to how we create and modify our investment models.
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Good morning and happy Monday! We took last week off as the U.S. celebrated President’s Day and all investment houses, banks, and government offices were closed in observance. However, the last two weeks were significant for both the economic indicators and the U.S. investment markets as the stark realization that inflation might have reversed its previous downward trajectory means the Federal Reserve must do much more for longer to resolve this continuing issue with high prices. The chances of a “soft landing” of our economy, touted often in the past few months by stock analysts as the reason for the recent stock market rally, are greatly diminished. We have much to discuss.
At-a-Glance:
- Inflation reverses and heads higher
- Housing continues its free-fall
- Ongoing jobless numbers started climbing
Inflation reverses and heads higher
We got updates to both major inflation measurements over the last two weeks: the Consumer Price Index (CPI) and the Private Consumption Expenditure (PCE). PCI is data that comes directly from consumer sources, while PCE includes data from businesses in its calculation, as well. For example, PCI might catch rising medical expense costs consumers are seeing, but PCE will also catch the cost of your employer’s match. These are different ways to measure the price pressures in the economy, and the Federal Reserve Bank pays close attention to each one. Having two different ways to measure allows for one to “check” the other; there is room to argue among economists when one number is up and another is down, for instance. But when both move in the same way, particularly in a surprise change in direction, the Fed must take notice, and they did.
First, after several months of the rate of increase slowing (note: a slowing rate of increase is still an increase – prices are not falling), the month-over-month CPI suddenly reversed and started rising again in the most recent reading:
This was reinforced a few days later with the survey of the PCE, which showed an even greater increase in monthly prices when business costs were included:
…which was even further reinforced by the most recent read of the US Producer Price Index (think CPI but only for business expenses – the cost of raw materials, transportation, rent, utilities, and the services businesses use to operate like accounting, legal, etc.):
What makes PPI so important is that PPI tends to lead and somewhat predict CPI in the coming months. Producers (companies) must pass on their price increases to the consumer in the final product, and while not all of the PPI increases show up in the store price of a can of spinach or a new television, a lot of it will. So we watch PPI to see where CPI will likely trend in the coming months.
We’ve argued for many weeks now that the recent declines in inflation were largely the effect of the US Dollar’s amazingly fast climb in strength compared to other world currencies in the last half of 2022. It’s a bit much to delve into in these brief updates, but as soon as the dollar started really gaining purchasing power late last year, price increases started cooling off. And it makes perfect sense: a strong dollar buys more “stuff”, and a weak dollar buys less. Our thesis was that as the dollar’s historic strength reversed in January, we would see price pressure start to climb again, and we did. This means much of the rallying the market did over the last two months, believing the worst was behind us, must also reverse. Wall Street was giving everyone a “high-five” since the middle of December, and very prematurely claiming the inflation monster had been slain. Grinning ear-to-ear, Wall Street began predicting the Federal Reserve would quickly declare victory and start lowering interest rates again. We said that was nonsense; that inflation is affected by many factors, and the one being overlooked by most of the analysts was the fact that inflation only fell while the dollar was historically strong and that if the dollar fell back to normal valuations, inflationary pressures would resume. So far, that appears to be what’s happening.
What this means to you:
As we’ve argued since August of 2001, and have reiterated over and over again in our weekly updates, inflation remains the single most significant challenge in our economy because of the damage it will do to the budgets of regular people, who make up 70% of our economy. We’ve said for months now that the Federal Reserve must do more than many on Wall Street are expecting, to return inflation to a stable 2% annual rate. Even though something like a 0.5% monthly CPI number or a 0.6% monthly PCE number is a one-off reading, if these numbers were annualized (meaning these became the trend for a year instead of the recent downward path of both numbers), we’re talking about a 6% yearly CPI and a 7.2% PCE for 2023. This would be on top of two previous years of about 6% and 8% CPI inflation we’ve already endured (and there is a lot of room to argue whether inflation was actually that low – our contention is inflation is much worse in real life than either the CPI or the PCE capture). The sudden reversal in every major index we use to track prices in the United States is very negative news. It means the Federal Reserve has not done enough so far to fix inflationary pressures in our economy, and must continue to increase interest rates and reduce the available money supply even further, and for longer than many had expected. The chance of a “soft landing” for our economy got much smaller with these readings.
Housing Market Update
We are always keeping an eye on housing, not only because many of our clients are homeowners already, but because many are saving up for that first major home purchase. We also watch the housing sector of the economy for two other more academic reasons: because so many other sectors of the economy from raw materials manufacturing to banking/finance depend on a robust housing market, and also because housing is the most interest-rate-sensitive sector of the economy. Watching housing’s reaction to the current Fed decisions will give us a forward glimpse of how the rest of the economy may fare in the months ahead.
As we’ve reported for over a year now, all is not well in housing, and it’s far worse than your local realtor or mortgage broker will admit. After the wild excesses of the last few years, rising interest rates combined with sky-high home prices have now crashed the housing market, and sadly, the trend continues to worsen.
The most recent data shows that Year-Over-Year Housing is significantly depressed, approaching the devastating levels of 2007-2009. What concerns us is, the Federal Reserve isn’t even finished yet, so the full impact on housing hasn’t even been felt.
First, construction is slow. Housing starts in general are showing up near the middle of the last 8 years of production…
But if you take out multi-family construction (duplexes, apartments, condos, etc.), the number is much worse:
Building permits, however, are much lower, so the houses that were started in January reflected purchase activity from months before. Permits need to be pulled months before a new house construction begins, and we can see that permits are down well into the area of the last Housing Crisis during the Great Recession:
Much of this has to do with how unaffordable houses are right now when you combine house prices and the current mortgage interest rates, which have started climbing again since late January:
This has led to an absolute collapse of mortgage applications, by far the worst mortgage market in the last eight years:
What this means to you:
The mortgage and housing industry is facing an extreme recession this year. There is a lot of argument that home prices will not see significant declines simply because there is so much demand for homes, but the simple fact is, if you cannot qualify for a higher-rate mortgage, you cannot afford a home at today’s prices. It really doesn’t matter how much demand for homes there is if no one can buy one based on the mortgage payment.
One of two things must collapse in order to restore enough qualified buyers to the real estate market – either house prices must fall significantly, or mortgage rates must drop by more than half. And since interest rates will not decline until the Federal Reserve’s goals on inflation are met, the only thing that can happen is the home value must fall. When you factor in the unfortunate loss of jobs and the resulting home foreclosures that typically follow, we strongly believe house prices will correct by 25% or more from their 2021 peak.
If you are in the market to buy a home, be patient. Buying conditions are getting better, but we have a long way to go. Timing your home purchase for the next 12-24 months will give you a much better opportunity to find a lower-priced home, but you must let the economy work itself out first.
Ongoing jobless numbers are ticking up.
We remain in a strong job market, with approximately 1.9 jobs available for every unemployed worker, and initial jobless claims remain low (for now):
I add the condition “for now” because we know that layoff announcements are increasing and more and more employees, particularly in tech and finance jobs, are being let go. We believe we are not yet seeing this reflected in initial jobless claims for two reasons. First, many of these employees are being offered significant severance packages, and there is a recent federal law that requires at least a 60-day pre-announcement of layoffs for most larger employers. The advance notice and hefty payouts are giving people the time to find a new job before they need to file for unemployment benefits. This is a good thing.
However, it appears that once you need to file for unemployment, it is getting harder to find a job. Continuing unemployment claims have reversed trend and are starting to tick upward:
What this means for you:
Companies lay off people as a last resort in most cases. They resist this because it is very difficult to find replacements for those employees once economic conditions return to normal. Plus, the costs of recruiting and training new employees is very high, particularly in the first few months of a new hire’s tenure.
So businesses resist laying off until the last moment. They will first stop hiring for open positions, and then reduce hours for current employees, and then offer early retirement or other voluntary departure incentives, before finally, laying off workers becomes the more final solution to reduce labor costs. That we are seeing some difficulty in unemployed workers to return to a job indicates that many companies may have halted hiring for their open positions, or are being far more selective than they were able to be in the past few years. It is another indicator that a recession is likely on the near horizon.
Bottom Line:
No one knows exactly when a recession will be declared, but we firmly believe most of the larger economies of the world are right at the door of one now. Recessions can take years to recover from, which is why we believe it is vitally important to get your family and business finances ready to weather through such a storm.
We predicted the beginning of a turn in the current market rally last week, and we reiterate that sentiment now. There will always be market movement that moves counter to the economic data because markets are much more short-term focused, and let’s face it: until fear takes hold, greed is the prevailing emotional state of most market participants. We do believe, however, that the recent rally has fully run its course, and there will soon be a strong shift from stocks and into safer investment options such as corporate and government bonds. With interest rates this high, getting a 5% or better yield, risk-free is becoming a more and more attractive option for investors concerned about the coming economic uncertainty. Once there is consensus that either the economy is earnestly deteriorating, or the Fed announces the end of rate hikes, the move from stocks to bonds will accelerate.
Whether you are our client or not, you need to consider the broader economy (and much less so the daily market fluctuations) when making investment decisions. The economy is telling us clearly what is coming, and you need to have your investment accounts prepared before that happens.
Use these economic reports, and those of others working in this space, 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 and fiduciary investment management 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 financial and portfolio checkup 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:
- Later Today: Fed speakers, Consumer Inflation Expectations
- Tuesday: NFIB Business Optimism Index, Official Consumer Price Index and January Inflation Figures
- Wednesday: Mortgage and Housing, Retail Sales, Small Business, Oil and Gas production reports
- Thursday: Jobs, Producer Prices, Manufacturing Indexes,
- Friday: Exports and Import data, Jobs
