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Good morning and happy Juneteenth holiday! Our office (and all U.S. government, bank, and financial institutions) are closed in observance of the holiday. The past week produced a combination of familiar and pretty uncommon numbers. Because we address some of them so often (housing, for instance), we’re going to focus this week on some less-than-usual data streams to assess where the economy is headed. We believe as the summer continues, the numbers will begin to surprise, and then panic, Wall Street, and we will be needing to update more than once per week. Check out Jeremy’s (almost) daily economy journal that you can read and subscribe to at “Think Like A Rich Guy”):

• At the Top: The Fed paused, but strongly implied more hikes are coming
• Jobs update
• Consumer spending and sentiment
• Inflation update: CPI and PPI
• Housing continues to cool

At the Top:

The Fed paused, but strongly implied more hikes are coming.

As expected, the Federal Reserve’s FOMC announced a pause in rate hikes until their July meeting, to allow an assessment of incoming financial data, particularly core inflation and employment. Chairman Powell, however, strongly urged the markets not to assume the Fed was finished with rate hikes, and forcefully reminded market participants that a 2% inflation target was the Fed’s dominating objective; other things will be allowed to “break” in order to meet this objective.

Core inflation, as we will touch on today, is very “sticky” compared to the Fed’s previous projections, and remains so even today. It’s made the Fed look pretty inaccurate in their previous projections so far, remaining much higher than they’ve expected (and ticking back up again). This has caused the Fed to have to revise its inflation expectations at every meeting for about the last two years.

Jobs Update

The weekly jobs numbers continue to puzzle me somewhat. On the one hand, hiring still looks strong, but both initial and continuing claims say the exact opposite. It’s true that we don’t have mass layoffs happening at the moment, but those who are laid off are having a harder and harder time finding another job.

Initial claims for unemployment benefits ticked up and are now starting to climb in a comparison chart of the last 10 years (but still below the average):

Jobless claims are significantly higher every week now, than the average of the last 3 “normal” years (the craziness around Covid removed):

And when we look back at just the year prior (how much has changed since the same month last year), a much clearer picture emerges. We are definitely seeing a cooling off of the labor market and many people are starting to lose jobs. Already, the labor market has deteriorated in a single year at the fastest pace since the last Great Recession:

But as I’ve said for several weeks now, it’s the CONTINUING claims that I believe, are giving me the clearest picture of a recession coming. At first glance, compared to the other years in a side-by-side comparison, continuing claims don’t look to be too bad (though the trend is against the seasonal norms and we’ve gone from the lowest in the decade to now only the fourth-lowest in just the last few weeks):

It’s when you look closely at the change from June of last year, that a true and clear trajectory emerges. Except in serious economic challenges (2008-2011 and Covid), the continuing jobless claims are typically VERY tightly connected with the previous year (because a lot of hiring surges and layoffs are seasonal, so a June looks like a June, which looks like a June). It is only when serious economic problems emerge that you see a wild swing away from the seasonal norms. And now, we definitely have one, in that our continuing jobless claims have spiked up dramatically since the start of 2023, and are now 30.1% higher than June of last year. That trend looks more like the spike in 2008 than anything else.

Looked at another way, there has NEVER been a continuing claims rate this high that did not accurately predict a recession.

So will this trend continue, or will it reverse? In the near term, we strongly believe that hiring conditions will continue to worsen, especially in the small business sector, where about 70% of all U.S. jobs are actually found. Here are some surveys of business conditions for small businesses.

First, retail sales have fallen off a cliff already the past year or so, but that is expected to significantly worsen as banks offer less and less credit to consumers:

We’re already seeing retail sales crash compared to the year prior:

And similar to the pullback in loans to consumers, banks are also tightening their lending standards for small businesses. The dark blue line is the current availability of loans and lines of credit for small businesses. Hiring/layoff trends lag behind a little, but closely follow this credit availability (or lack of it).

And already, we are seeing companies hiring less and complaining about the tight labor market much less than they were even a couple of months ago. Here are the number of times companies mentioned labor shortages in their corporate earning conference calls:

 

And the number of job openings, in all authoritative surveys, is declining rapidly:

What this means to you

Layoffs have been happening all year so far, but until now, most of those who lost their jobs were able to quickly find a new one, often before their severance packages ran out, and so they never had to file for unemployment benefits. That has definitely changed. New filings are up, which indicates that people can’t find new work before their severance packages run out, and continuing claims are now the highest (excluding Covid) since the start of the last significant recession. Sadly, we anticipate much worse labor conditions in the coming months as business conditions worsen, particularly in the small business sector.

Recessions don’t mean a huge number of people will lose their jobs. It might mean our unemployment rate climbing from 3.5% today to maybe 5% or 6% – still a major impact on consumer spending and therefore, economic output, but it doesn’t mean the end of the world. However, that said, the most important thing you can do to prepare, particularly if your job is at risk in any way, is to make sure your monthly expenses are minimal and you have sufficient emergency savings. We can help you with both of those goals.

Consumer spending and sentiment

With jobs and businesses feeling the squeeze, it would make sense that consumers would start reacting to protect their savings and “batten down the hatches” for potential job insecurity. The most recent University of Michigan sentiment survey shows that consumers have been a little more hopeful since inflation started moving down last year (and the stock market rallied up a bit, in our opinion: unsustainably and right before the recession begins):

But when asked how things are now versus 5 years ago, the story isn’t a happy one:

Consumers are also telling surveyors that they intend to pull back on all of their spending that isn’t absolutely necessary (we call this “discretionary spending”):

We are already seeing (thankfully!) consumers spending less on credit cards in the last few months, and believe this trend will continue:

One thing I’m particularly concerned with right now is the delinquency rates on credit cards, as we can see here. They are spiking up in every income bracket, but much more so in the lower 60% of incomes. These are the consumers most negatively impacted by inflation anyway, so I’m afraid many of them have been using the credit cards to make ends meet each month, and were putting even gas and groceries on their cards. As interest rates have climbed over the last year, so have the rates on those cards.

One of the questions I am often challenged with by impatient clients and market “bulls” online is: “where is this recession you’re been warning us about”? A fair question. The data tells us that the trajectory is NOT wrong, but it took longer to drain out all of the excessive government giveaways that happened during the Covid pandemic than many economists expected. If anything, the assessment we’re making of a recession was just early, but we are 100% convinced we are correct in where this is all headed, and this is why we’ve been so protective with our client funds over the past year.

When will the recession really get here? By some measures (Manufacturing and now Service ISMs, for instance), it’s already here. But since consumer spending makes up about 70% of our total economic activity, it will hit as consumer spending slows, and bottom out somewhat after consumers are out of money. Nearly every major bank and investment firm, in addition to government bodies, are tracking this closely. Though their paths hit “ZERO” and go negative for consumer spending at slightly different speeds, the assessments are universal.

Let’s examine a few. First, researchers at Morgan Stanley show spending crashing from a peak at the beginning of this year and reaching a bottom in the third quarter of 2023, with a VERY slow recovery out of it and well below historical averages in consumer spending:

Next, we have Deutsch Bank, which is projecting consumers to be out of cash right at the start of 2024.

Wells Fargo analysts predict a rapid drop in personal savings all year, with it bottoming out sometime in 2024:

The government’s own estimates puts consumers out of excess savings in mid 2024:

 

And another analysis breaks it down two ways: first, do we spend and save “like normal”, using a more conservative spending rate from 2016 to 2019 (the green lines), or do we spend like we did in 2019 (much more aggressively) – the blue line?  In a more aggressive scenario, consumers are out of cash in just 4 months. If they are more thrifty, it’s just a year later.

Student Loans: the one thing everyone keeps forgetting

The one thing that makes me believe we will see consumer spending drop much faster and much harder – by August of this year, even – is the fact that Student Loan Payments will resume in October. Student loan forbearance meant that almost two TRILLION dollars of debt that there was no interest and no payments being made on since early 2020 (and which consumers have long ago stopped setting money aside for) became the money that kept the economy humming along since Covid. 

THIS ONE SINGLE FACTOR is one of the primary reasons we had the jump in spending, and has propped up the economy for the last three years. The student loan forbearance, the stimulus checks and the PPP business loans, all created the inflationary problems we’re facing today.

That is coming to an end in just four months, and notices are already being sent to student loan holders of what their payments will be. 

People with student loans, and there are a LOT of them, have to now reinstate those loan payments back into their monthly budgets. The AVERAGE student loan payment is between $621vper month for a bachelor’s degree, but this varies wildly by the level of education and income level (since repayment plans can be income-based):

Those monthly bills are coming due this October once again, which will radically alter post-Covid spending habits.

I believe the slowdown in spending for these consumers will be immediate and will impact nearly all of the summer’s nondiscretionary spending, as these borrowers start to readjust their budgets for the resumption of those loan payments.  It will be quite a shock to many family budgets that got used to spending the loan payment on other things. I truly believe this may be the “wrecking ball” that sends us from what might have been a soft-landing type of recession, into a much more serious one. We’ve been preparing our clients’ funds for this for a year now.

What this means for you

I cannot stress enough the importance of budgeting your family for a slowdown in economic activity and doing the same – to a greater degree – for your small business. If you need help with this, particularly with debt payments as interest rates rise and budgets get even tighter, please reach out to us for a free financial audit.

Inflation Update: CPI and PPI

Inflation presents some good and bad news for us this past week. First, PPI (the Producer’s Price Index), the prices companies pay on raw materials, shipping, energy and labor, continue to drop significantly. This is a good long-term trend:

But a lot of this was due to what is called Cyclical inflation and Supply Inflation. During Covid, it was often difficult to get raw materials, and so costs climbed until the supply chains were fixed. They are definitely fixed now, with trucking and shipping actually below normal capacity by quite a bit as of last week.

However, CORE PPI (the stuff companies pay for regardless of supply conditions or economic activity, remains “sticky”:

So while the trend is good, there is still work to be done to bring prices down sustainably.

 

Now after the product is made and delivered to the store, the price change becomes CPI (consumer price index), which we can see is down from the overall peaks, but still hanging on stubbornly, and the trend the past 3 months is that it is starting to tick up again month-over-month (top chart). However, CORE CPI (again, the stuff you buy most often) remains very stubborn (bottom chart):

When we look year-over-year instead of month-over month, we can see a better trend in making progress on CPI (top chart) but CORE CPI (bottom chart) remains very difficult to pull down:

Is inflation really trending back down, though? One of the things we have to watch, in addition to the backward-looking (we call them “lagging” reports like the ones above, are the current prices of commodities (the raw materials and staples that make up the CORE). Last week, inflationary pressures resumed in most of the areas that make up CORE inflation:

What this means to you

We strongly believe inflation is not finished, and if the Federal Reserve lets off the “gas” on its quantitative tightening process too quickly, inflation will resume upward. In fact, we can already see commodities rising again this past week. Anecdotally, I’ve personally seen gasoline at our closest convenience store rise from about $3.29 a gallon to over $3.70 a gallon just this past week.

We believe there is much more work to be done on inflation before the Fed can finally pivot and start the healing process.

Housing Update

Finally, a quick update on mortgage applications, which gives an overall look into the health of the credit market. We’ve previously documented our concerns about the real estate market going into this recession, especially the potentially devastating impact on commercial real estate. But we do believe that because so many residential homes were purchased as investments, we will see the residential marketplace impacted more significantly than many other analysts as interest rates on business loans rise (Remember – if you buy homes to rent out or to AirBnB, you don’t get a 30-year home loan for that property. Often you only get a 10-year business loan, many of which have fluctuating interest rates.)

As interest rates have started to climb again, mortgage applications have dropped. Remember, we are at the peak of the mortgage market for the year (June is when most families move), and it will worsen from here for the rest of 2023. We are already at the worst mortgage market in the past decade:

Similarly, rate locks (loans that appear to be headed to a successful closing within 30-45 days) have also diminished significantly:

What this means to you

Our estimated trajectory for the housing and mortgage industry – into a housing recession – remains on track. It is not a good time to sell your home, but it’s better to sell now than it will be a year from now. Conversely, if you are looking to buy, be patient and get your credit and debt situation optimized, because we believe there will be strong buying opportunities in 2024 and 2025.

Bottom Line:

We remain convinced that a recession is imminent, even as the market fights back hard against it. Do not let the current market rally fool you – there is no sustainable way to grow profits (and therefore a supportable stock price) in an economy that is rapidly losing steam. Corporate profit reports are backward-looking and economic projections are forward-looking. Do not be lulled into complacency just because the stock market allows itself to.

We’ve been alerting our clients for nearly two years now that inflation was going to cause significant problems and our central banks would have to take progressively stronger actions to combat it. That appears to be a correct call.

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 runs 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 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.

Just this past month, I published an ebook to help you get your finances ready for the recession directly ahead. It’s yours totally free. Just click on the book image to access and download it.

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:

• Jobs Report
• Service Sector Update
• Commodities

The views and opinions expressed in this economic outlook are for information purposes only and are not intended to be financial advice. nVest Advisors, LLC does not provide specific investment or financial planning advice to a client without an executed client service agreement. nVest Advisors, LLC does not trade directly in commodities or cryptocurrencies. Economic data changes rapidly; no warranty is expressed or implied about the reliability of this data once published. Although the information provided here is derived from authoritative sources, we cannot guarantee the accuracy of this information. Please see our general disclosure page for additional details.