Our Economic nSight articles 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. It is copyrighted and may not be republished in whole or in part without written permission.

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 by reducing various short-term market risks and enhancing portfolio performance over time.

For more information about our investment philosophies and management style, click here. To receive these economic updates and other company news via email when they are published, always free of charge, please subscribe here.

Good morning and happy Monday! Hard to believe this is our last Monday in June! We had a fairly light week in economic news but this coming week is significant, so there will be lots to share with you right before the July 4 Holiday. Be sure to subscribe so you don’t miss an update.

Keeping up with global economic data is a monumental task. With a financial planning and investment management firm to run, that is committed to doing our own independent research, we are forever grateful to the many excellent Economic aggregation resources that take the work out of gathering this data for us each day. They don’t give us analysis – that’s our job – but just compiling this information can be a full-time job. We want to give a big shout-out (and a thank you) to MacroMicro, TradingEconomics, and The Daily Shot. These are three of our favorite places to see a daily aggregation of economic data, and you’ll often see their charts used here. Also, though it’s spotty so far, I want to blog a daily journal of economic activity as we head into this recession, which will shortly include daily market and trading activity. You can find those at my personal finance blog (undergoing a complete rebrand this summer): “Think Like A Rich Guy”):

• At the Top: Volatility and the Markets
• Jobs Update
• Housing update
• Leading Indicators
• Manufacturing and Service Sector Updates

At the Top:

Volatility and the Markets

It’s been fascinating to watch the investment markets surge this year, especially from the perspective of a macroeconomist. All of our data (presented here with a realistic and objective analysis) points to a slowing economy and perhaps even a steep recession. There is a multitude of objective data sources that show this slowdown clearly, and there are even economic indicators that are wildly – even historically – out of “whack”. Yet, still, the markets are trying too hard to rally. Last week, that wild optimism finally reversed, as the reality of the Federal Reserve actually having the resolve to combat inflation, coupled with the reality that inflationary pressures are nowhere finished (as we’ve said here for many weeks now), grabbed the market’s attention.

We currently live in an economy that doesn’t know where it is headed – take jobs, for instance. Hiring remains elevated, but so does the number of new and continuing unemployment claims. Both of these cannot be right.

The same thing with housing. Housing starts surprised to the upside in May, as you will read below, but mortgage rates have spiked, mortgage applications have collapsed, and home prices are falling. Which is correct?

Nearly 20 years in this business have taught me a few things that are universal truths: despite all the training I got early on to believe that markets are efficient and rational, they are in no way either one. Markets are often referred to as a “random walk” day-to-day. It’s a matter of how many buyers vs. sellers wild casinos on a daily basis, fraught with cognitive bias and herd mentality. They are rarely efficient in the short term. They are emotional basket cases; if you could date “The Market”, you’d probably not ask for a second date once you saw the emotional volatility.

Also, most market participants are not long-term investors. They are there to trade for short-term gains. Market traders make a living riding the roller coaster. I could go on further about the implied lack of ethics in market trading (in which there must be a winner and a loser in every trade), and how it contrasts with actual investing (in which someone with capital sees a company with potential and wants to invest in its future success), but I digress.

What we know about the economy is this: nearly every data point we can track points to a coming slow-down, and the current trajectory of the Federal Reserve’s FOMC cannot do anything else except slow the economy. We know there is a lag effect of several months from some of these decisions before they show up in the broader economy. We also know that no economic number moves in a totally straight line – there will be mini-peaks even along a longer-term downward trend.

Yet, the market rallies, in our opinion foolishly, as we head over the economic cliff. This is also a normal occurrence, sadly. In many recessions, markets move up and even speed up, right before the collapse that everyone always later calls a “surprise” or “unexpected”. That’s nonsense. The economy is waving red flags all over the place. We remain strongly convinced that a recession is inevitable.

Here are just a few of the reasons we don’t often share with our clients and readers as to ancillary data that wholeheartedly supports our thesis. First, the Yield Curve of U.S. Treasuries. When short-term treasury bonds have higher yields than long-term bonds, we call this the Yield Curve “inverting”. It is an almost perfect indicator of a recession in the next year or so. The curve inverted in the late spring of 2022, and as of today, that inversion has never been worse. Every time the curve inverted by even a small amount, a recession immediately followed. Look where it is today:

Looking at it through the lens of a diffusion index, we see the very same conclusion: we are at the peak of a yield curve inversion that has only ever, in the past, led to a recession.

Yet the markets are wildly bullish; in our opinion, foolishly so. The red line is the current sentiment among retail investors (that’s you and me).  Why the optimism? Surely not because of what’s ahead of us. Quite the opposite, actually: investors are optimistic about the future because of the last six months of rally that are already in the rear-view mirror. Forward optimism is often the result of a backward-looking response to market movement.

Here’s the kicker, though: the smart money – the institutions – know the game is up, and are positioning for the inevitable drawdown. Below is a comparison of how often the VIX (often called the FEAR INDEX) matches the movement of the S&P 500. Because the S&P are the stocks of companies, upward movement in the S&P would indicate optimism and increased investment. When the VIX moves up, however, that indicates growing uncertainty and fear. So in theory, the S&P and the VIX should move in opposite directions (negatively correlated), and you can see that for the most part, they do. Right now, however, they are moving in the same direction, historically so. That means that for all the wild optimism, there are smart, often institutional investors positioned to have the floor fall out from under all of this celebration.

We can see this blind optimism a little more clearly in the sentiment indicator below: markets are FAR too optimistic at the moment and like a rubber band that gets stretched too far up from what is realistic, it will eventually need to “snap back”.

One very simple reason why this is not sustainable? Companies are finding it harder and harder to obtain credit right now. That will automatically mean less investment in their companies, fewer capital expenditures, lower payroll, and overhead expenses, etc. The economy is not doing well, it’s warning us all over the place. The smart investor will heed the warning. Despite how ornately the market wants to decorate its house, the economy is the foundation, and it doesn’t matter how pretty the house is if the foundation is rotted beneath it – it WILL come down.

 

Jobs Update

The weekly jobs numbers showed an uptick in initial claims for the week, kind of in line with seasonal norms but also rising significantly since the start of the year. This is the sixteenth week in a row of jobless claims coming in higher than the average of the last 4 “normal” years: 2017, 2018, 2019, and 2022.

As I’ve said for the past few weeks, though, it is the CONTINUING claims that give us the more clear picture. Continuing claims have continued to increase relative to previous years, and while still not anywhere near the highs of 2014, 2020, and 2021, they have moved from the lowest in a decade to the middle of the pack in just a few weeks.

So are jobs looking to rebound anytime soon? Not according to many parts of the economy. Here is just one example, from data reported by the Kansas City Federal Reserve this past week (more on them below):

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.

Housing Update

We got a deep-dive into the housing market this past week, with a lot of data that shows optimism from builders (mainly because the raw materials costs for housing is finally lower), but the mortgage data shows consumers are just not buying. So we have an issue with builders building, but no one being able to afford the homes they’re making. We believe this, along with the downturn in the economy later this year, will cause a bit of a “glut” in housing that isn’t being seen yet, but might cause a good buying opportunity in 2024 and perhaps 2025.

First, homebuilder sentiment jumped higher than expected, as their anticipated sales also climbed. We believe this survey was taken before the very strong announcements by the Federal Reserve to expect higher interest rates for longer last week, and this sentiment will reverse in the coming months.

But that didn’t stop home builders from jumping on lower building costs to start a lot of new housing projects:

Building permits are not at the same highs, so there may be some cooling off already built into the drop in sentiment that we anticipate, but still looked good:

There was a spike in single-family houses starting construction:

That was slightly tempered by the survey by our central bank, which showed an actual cool-down.

Where real activity is moving is in the multi-family housing, spiking to a decade-high, perhaps in anticipation of home prices and interest rates remaining elevated and keeping many families from being able to buy their own homes:

This time, the Fed’s data confirmed the spike in housing units for multiple families:

However, mortgage purchases are still at a decade low and continue to down-trend…

… and rate locks, which means a home sale is imminent, are also at years-long lows:

 

So now, we have an impossible mix of data: mortgage applications collapsing, but homebuilder sentiment soaring. Normally these two, for totally obvious reasons, go together very closely. We believe the current conditions are ripe for a surprise collapse and sudden surge in the inventory of new homes later this year and for much of 2024, leading to a sizeable drop in home prices.

Mortgage rates have peaked again and do not appear to have any reason in the coming weeks to abate:

So why would builders be moving to build so many homes, if they are so difficult to acquire for most families? It may be because the price to build a home has become much less expensive, so builders may anticipate being able to offer greater price reductions if conditions do not improve, and still be able to book a profit on each home:

The only thing keeping up the prices of existing homes as much as they have so far (though the average home price is down about 4% from last year’s highs so far) is that so few homes are on the market at the moment. We do not believe that will continue as the recession worsens and this glut of new homes finishes completion.

What this means for you

The housing market is now at a crossroads – buyers are few but builders are optimistic and building anyway. Logically, this will create an economic surplus, which should drive home prices lower over the next couple of years.

Leading Indicators

We cannot stress again the significance of the Conference Board’s Leading Indicators Index (going forward six months). This index merges a variety of forward-looking economic indicators together into a single view of the coming economic conditions for the country. Anytime in the past, going all the way back to the index’s creation in the 1960s, when the indicator was this low, a recession was imminent.

And as I say often in this blog, it’s all about trajectory and velocity, not the most recent number. So how is this leading index faring on a month-to-month basis? Is it improving its trajectory, or continuing to decline? The answer is shown below:

What this means to you

We cannot stress this enough: literally every indicator showing a coming recession is flashing red. Do not let complacency (or impatience) get you back into an investment market before the bottom has been reached. The investment markets will bottom out before the economy does, but we are nowhere near the market bottom, in our opinion.

Manufacturing and Service Sector Updates:

Confirming the slowdown being predicted by the Leading Indicators (above), we got manufacturing and service updates from the Philly and Kansas City Fed this past week, as well as some combined national and global statistics. First, Kansas City Manufacturing came in MUCH lower than expected, and deeply in recessionary territory:

And as we showed you above in the Jobs update, manufacturing in this region has started layoffs in significant numbers:

Similarly, in the Philly region, the services info came in this past week, showing a marked decline in the Services sector, also:

This also showed a significant downward revision in employment for both full and part-time permanent workers, as well as temporary hires:

Also, the S&P global production indexes were released, confirming that the slow-down is not limited to specific parts of the U.S. or even the United States as a whole. Global manufacturing shows in recession:

However, Global Services are still treading water for now, though both their input and output prices are plummeting. This is a good thing for consumers eventually, but it means that demand for their services is dropping rapidly:

What this means to you

Forget what the market is doing – this is what companies themselves are telling you is going on. Both the Manufacturing and Service sectors, here in the US and abroad, are pointing to a rapid slow-down in their business prospects. We need to make sure we are properly protected against the slow-down in sales which will sadly include job losses and even some business failures.

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.