Jeremy Torgerson, CEO, CIO & Senior Advisor
Our Economic nSight articles are typically 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.
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Good morning and happy Monday! After a week off to relocate our company to our new downtown Colorado Springs office, we’re back with a quick look at the economic data over the past two weeks, and how they are impacting the investing strategies we use for our clients.
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. Though we use several more, 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 been 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. Sadly this has taken a back seat in recent weeks to massive (and great) changes happening here at nVest Advisors, but we’ll be back in the routine in August. You can find those at my personal finance blog (undergoing a complete rebrand this summer): “Think Like A Rich Guy”):
- At the Top: The U.S. credit rating was lowered
- Housing update
- Manufacturing and Service Update
- Jobs update
At the Top:
The U.S. credit rating was lowered from AAA to AA+ by Fitch
The markets reacted to the lowering of the credit rating for bonds issued by the United States Treasury last week, as the reality of higher interest rates and the impact on government spending starts to take effect. Fitch is one of two major credit-scoring companies for corporate and government debt in the U.S. (the other being Moody’s), and just like you and I receive a credit score from the three major consumer credit reporting agencies, companies and governments have the same kind of rating system (typically a wild mix of letter grades instead of a number like consumers get).
The lowering of the credit rating of the United States government wasn’t completely unexpected but it was not good news, either. In recent years, the United States has added tremendous amounts of debt to its books. This started in earnest during the Covid pandemic but has continued at a rapid pace, the most recent being the addition of over $1.6 Trillion (that’s 1.6 million million dollars – $1,600,000,000,000) just in June of this year after Congress approved a new, higher debt ceiling.
The difficulty isn’t just the debt load, which is substantial. It’s that interest rates are rising on the repayment of that and all previous debt, and tax revenues are declining for the United States as the economy slows. Although the Federal Reserve Bank typically buys the bonds created to sustain government spending, those bonds pay a higher interest rate than in years past. The U.S. government also has bonds maturing (coming due) all the time from earlier points in the past that must be refinanced today at higher interest rates. This has caused the interest payments on government debt to spike substantially in recent months, to become the largest single thing the government spends money on.
We are now in a situation where the government is on a trajectory to spend more each year to pay for its past expenditures (that it had no money for) than it will on current-year defense, infrastructure, Medicare and Social Security demands. It’s been climbing with our very high spending since the Great Recession of 2008, but it’s accelerating quickly.
It is for this reason, plus the fact that the government does not seem able to pull back its spending in any meaningful way, that Fitch lowered the credit rating of the U.S.
The impact of the credit rating drop will mean that fewer investors may have a desire to hold U.S. Treasuries long-term. Although AA+ is only one notch below AAA (the highest rating), it lowers the U.S. as a whole in terms of perceived safety and a risk-free place to hold money.
What this means to you
Obviously, this credit rating drop does not mean major changes for the United States government, but our increasingly deep budget deficits cannot be sustained for any length of time. Austerity measures will eventually be necessary, which means politicians not able to spend freely to garner votes. They’ll probably continue to make campaign pledges promising various spending that is politically expedient (just this past weekend, President Biden’s Twitter account started talking about giving school teachers more money), but with failed promises in student loan forgiveness and green energy spending, they can’t keep kicking the can down the road for too much longer.
The solution is to move the country toward solvency, and no one will want to be the political leader who has to come out and say so after decades of the U.S. government acting like Santa Claus all over the world. Foreign aid, social spending, and even military budgets will need to be pared back, and taxes will likely need to increase. It is no wonder that, even though the “bill is due” for decades of rampant previous spending, no politician wants to step up and tell us the ugly truth. It will happen eventually, but not yet.
We are already in a precarious situation because we’ve depleted much of our weaponry and projectile arsenal supporting Ukraine (plus about $100 billion in borrowed money), but the Biden Administration also substantially depleted our Strategic Petroleum Reserves over the last 18 months to try to contain energy prices. Biden believed the U.S. would re-stock those reserves after oil fell below $60 per barrel, but OPEC nations cut back production significantly since May, which is sending oil prices back into the $80+ range this summer (we expected that and wrote about it extensively).
We anticipate that the United States will be forced to reduce its governmental spending and raise taxes in the coming years (likely after the 2024 election cycle). This will occur during a recession we remain adamant is approaching quickly. While we are always optimistic about the future of America (because We the People are “America”, not our political leaders), the next few years will be challenging. We remain invested to take advantage of higher energy and utility prices but otherwise remain largely outside the stock market, which we believe is seriously over-bought.
The bottom line is: we cannot continue to spend money we do not have. No family can do this, no company can do this, and no government can do this long-term.
Housing Update
We continue to remain watchful of a downturn in residential real estate. So far, housing has held up pretty well, though there are signs of decaying home valuations, largely in the Northeast and along the West Coast as far inland as Denver, CO.
Mortgage applications are slowing down a little sharper than seasonal trends (it’s very normal for home buying to cool off going into fall and winter). It’s still the slowest year in a decade for the mortgage industry…
… and as interest rates on 30-year mortgages have started climbing again, we expect this trend to continue:
Of note is how many rental vacancies there are vs. homeowner vacancies. Rental vacancies are trending back up again after a decade-long decline, but homeowner vacancies are at a historic low. This means that homeowners are not leaving, and as a result, very few homes are available for sale right now.
This single factor is what is keeping up home prices … for now.
But we are concerned about a couple of things. First, as the economy slows down, additional homes will be vacated involuntarily as, frustratingly, jobs are lost and small businesses close their doors. We do not believe we are witnessing a housing drop as bad as 2007-2011, but we do expect to see home prices fall 20% or better from their 2021 highs before it’s over. We are already seeing an uptick in current homeowners “interested” in putting their house up for sale in the near future:
The other concern came to light last week but may indicate much worse systemic problems in the residential housing market, related in many ways to what we expect to see in commercial real estate. The Philly branch of the Federal Reserve published a report that is worth the read for those who are interested. In it, they note that there appears to be widespread fraud by real estate investors who falsely claimed that the homes they were buying for either long-term rentals or short-term “AirBnB”-type rentals, were actually primary residences. This would have allowed many of them to be purchased with 30-year residential mortgages instead of 10-year adjustable-rate business loans:
If there is widespread misrepresentation underway (and indeed the Fed report says this is “ongoing”), it caused, by the Fed’s own estimate, a false estimate of a home buyer’s market that may be 50% larger than it really is. This is a huge number and would indicate that home values are far too high for actual market demand and that a large number of homes that were bought by investors – but falsely called primary residences – have created an asset bubble in residential real estate of comparable size to the one that exacerbated the Great Financial Crisis of 2008.
What this means for you
Housing looks strong – but we are now seriously concerned that this is a false indicator. Clients who are interested in buying a home or a second home may very well have the opportunity to do so at dramatically better prices in the next 18-24 months, but other clients who are interested in selling property may have a long time to wait for those home prices to return. Our macro models are not invested in either real estate or mortgages/property finance at this time.
Jobs Updates
There is a growing disconnect between the two major jobs reports (ADP and the BLS’ “JOLTS” figures), which we will discuss in more detail next week. There is also a disconnect between the first “print” of the numbers and later revisions.
It’s important to note that there isn’t an actual count of new jobs being created anywhere in America. Instead, we receive an estimate based on computer modeling that tends to be revised downward – often significantly – after the initial estimate is created.
Weekly jobs numbers showed, as has been the norm for a while now, a robust, though definitely slowing, job market.
However, we are now starting to see “cracks” in this narrative. The number of job openings in the US is cooling off rapidly as employers leave open positions unfilled and hiring slows.
The hiring of temporary workers has also slowed further. This is the sixth month of negative temporary hires, and the worst number of the year so far.
The number of hours in the average workweek is also slowing (this indicates slowing production at the company, as well):
And average pay is rapidly cooling off, as well:
A neat way to watch and verify job openings in the US is to watch the amount of income tax that is reported by the IRS. There is obviously a slight lag (2-4 weeks) between a newly hired (or fired) employee and the impact on income tax receipts, but we can see in this chart that personal income tax receipts are far below the reported job openings already. This would indicate to us that the number of job openings is either too high (the computer model missed it), or they are about to be dramatically lowered:
Remember, too that there is a lag between losing one’s job and filing for unemployment benefits. Current initial claims continue to look good overall:
Except that we have had 20 weeks of higher claims than the same period of time over the last three “normal” years:
But as I’ve said for weeks now, it is the CONTINUING jobless claims that is telling us the most accurate picture. Continuing claims are notching up slightly but have risen strongly relative to the preceding decade. The second chart shows how significate the continuing claims are compared to history. This tells us that once laid off, it is becoming very difficult for a worker to find a new job.
What this means to you
The job market is about to get much worse as we head into a recession. We urge our clients to reduce their debt load and increase their personal savings, and keep investments conservatively positioned for now. A recession doesn’t mean the end of the world, but it does mean seeing our unemployment rate climb from its current 3.5% to maybe 5.5% or 6.5%. That means, sadly, a lot of lost jobs and financial hardship for many families, so please take the risk of job insecurity seriously.
Manufacturing Updates
A quick look at some of the manufacturing data we’ve received the past two weeks. There has been no change in the trends downward. First, Dallas:
Chicago is also struggling:
And this is confirmed by the national survey:
Without question, factories across the U.S. are now shedding jobs:
The services sector is still treading water but the trend is into recessionary area, also:
What this means for you
The economy is continuing to slow and the pace of economic deceleration is increasing. We remain committed to our defensive positions as shown in our Macroeconomic modeling.
Bottom Line:
Download our brand-new E-Book “7 Hacks To Recession-Proof Your Financial Life” today.
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
