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!
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.
- At the Top: Inflation concerns persist
- Housing update
- Jobs update
- Small Business Update
- How is the consumer holding up?
At the Top:
Inflation concerns persist
We received an update to the official CPI numbers (reflecting prices into July), and for the first time in many months, inflation ticked upward. This is something we have been concerned about for some time now. Even more concerning is that the data for the CPI report was gathered before a significant upward move in energy prices that we believe will continue into the winter months. We’ve discussed that concern for many months (that energy prices were held artificially low by the Biden Administration’s draining of the Strategic Petroleum Reserve in 2022).
We’ve also talked many times about headline inflation vs. core inflation, and that core inflation is the primary concern for the Federal Reserve in its battle against inflation because the components of core inflation are those items that families will have to spend the majority of their budget on, the majority of the time.
First, headline inflation came in as increasing Month-Over-Month again, with prices rising 0.2% higher than they were in June. You can see that the rate of inflation, while slowing, is still climbing:
The CORE inflation similarly rose 0.2% over June, and remains persistently high at about 4.8% annual increases. This is the third year in a row for inflation to be climbing, and Core Inflation tends to be much more “sticky” than the Federal Reserve wants it to be. The goal for the Fed is to have Core inflation at 2% annually, and it remains stubbornly 2.5 times higher than that despite the fastest rate hiking cycle in history.
Services CPI by itself also showed remarkably stubborn inflation, as service prices rose 0.4% over June, a reversal from previous trends.
What we are concerned with inflation is that it tends to ride in waves as central bankers take their foot off of the economy’s “brake” too soon (out of fear of causing a more serious economic downturn), and as a result, inflation resumes an upward trajectory. The most recent inflationary cycle we can compare the current trend to ran from 1966 to 1982. Initially sparked by spending on the Vietnam war and the passing of Civil Rights legislation that dramatically increased entitlement spending, the blue line below shows that inflation rose in three successively larger waves until finally being “broken” by then-Fed Chairman Paul Volcker in 1980-1982. Volcker was forced to raise interest rates above 18% for a period of time, and effectively force the economy into a hard-landing recession, to finally bring inflation back down.
We see already how closely the current inflationary cycle (overlaid with the 1966-1982 cycle in orange), is tracking with the previous cycle, and how the waves are nearly identical both in scale and duration. We remain very concerned that despite most of the market sentiment that inflation has been beaten, this is not the case, and inflationary pressures persist:
- Energy prices are climbing again and there is less and less supply. Where energy prices go, so goes the price of everything else, because it takes energy to manufacture, transport, store, and deliver pretty much everything in our economy. Add to this the fact that the U.S. government must refill the strategic petroleum reserves at a time when production by OPEC+ nations are scaling back production, and the number of active oil rigs in the U.S. is rapidly declining. Energy stocks have risen over 12% since the last CPI data was taken.
- The U.S. Government simply cannot stop spending. Since the debt ceiling was raised in June, the government has added another $1.6 trillion to the national debt, far more than any other year except the Covid-19 shutdowns. When you match this with the higher interest rates they must pay due to the Federal Reserve’s rate hikes trying to tame inflation, we will have more than $1 Trillion – just on interest payments on our debt – for the first time in our nation’s history. All of that had to be newly printed by the Federal Reserve. You cannot tame inflation if the amount of money circulating in the economy keeps expanding – that is literally what “inflation” means.
- Housing prices rebounded in July and don’t accurately reflect the current CPI numbers. Housing is a significant portion of Core CPI, and home prices remain stubbornly high (for now).
- Food prices are climbing again. Some of the increase is related to weather or crop issues, but many are rising simply due to broad inflationary pressures.
What this means to you
Obviously, there is a lot of work still to do to get inflation under control. This will mean even higher interest rates, held high for even longer than many people expect. The recent stock market rally, particularly in tech and real estate stocks, was based on the (in our opinion, errant) notion that rates would soon be coming back down. If that does not happen, we may see an even more serious recession than most analysts have predicted, and certainly more than the markets have priced in. The reality that inflation is not beaten has started to finally dawn upon many market participants who until a week ago, were cheering for new highs in the markets before the end of the year. The market turned negative last week, and we believe that trend will continue. Our clients remain invested based on the reality of the macroeconomy and the expectation of a recession, perhaps as soon as Q4 of this year (especially when student loan payments resume in 45 days – more on that below).
Housing Update
We continue to remain watchful of a downturn in residential real estate. So far, house prices have held up pretty well, though a recession will cause a number of job losses which will sadly translate into lost homes, as well. We are growing more and more concerned by this possibility as the totality of household debt is now at record levels due to consumer spending combined with a rapid climb in variable interest rates. At the peak of the 2006-2007 housing bubble, homebuyers’ debt-to-income ration reached an unsustainable 39.1%. Today, it’s at 40% and climbing:
Mortgage rates remain near multi-decade highs:
And banks are starting to tighten their lending standards, rejecting more loan applications. You can see here that even those with better than 760 credit scores are no longer getting morgtages:
Total mortgage applications remain at decade lows and are trending lower:
I want to reiterate another concern that came to light last week, that 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 impression 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 mortgage/property finance at this time.
Jobs Updates
We look at jobs regularly, and the current trajectory remains unchanged. Initial claims, while still low, are trending higher, and continuing claims remains my most persistent worry. Total nonfarm payrolls came in lower than expected, continuing to follow the same downward trend since January 2022.
However, this week, I wanted to highlight that long before companies lay off employees, they will do other things first, including not filling vacancies, offering early retirement buyouts, reducing the use of temp help, and finally, reducing hours for all employees more or less evenly. We are now definitely seeing the hours at the lowest since Covid:
Also, it’s interesting to look at anecdotal evidence for confirmation of a trend, and often to get more recent information than a government report. In this case, let’s look at LinkedIn, which tallies new jobs being added to their user profiles. The standard mean of 1.0 means hiring is constant, but anything below 1.0 means more people losing jobs than getting jobs. But the current month (dotted line) and the 3-month average are showing layoffs are increasing:
What this means to you
The job market is about to get 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.
Small Business Outlook
The NFIB is a political action group for small businesses, which as you can see by their membership, consist of many very small companies:
Each month, the NFIB surveys its members and asks how business conditions are for the smallest of U.S. companies (where interestingly, over 70% of all U.S. jobs are found). Small businesses depend on credit to survive between payments of contracts and to expand their operations. When banks begin tightening their lending standards as we head toward recession, small businesses will feel it first. We’re not in recessionary territory yet for lending outlook, but the trend is definitely lower:
Small business is seeing a significant slowing of sales, down 13% from a year ago:
And optimism is bouncing up and down at a multi-year bottom:
What this means for you
The economy is continuing to slow and small businesses will feel it first and hardest. We watch the NFIB surveys closely because they are a leading indicator for the larger economy, and also a good precursor for where employment trends will be headed.
How is the consumer holding up?
There is a lot of speculation by investors looking only at company stock prices, and listening to earnings calls, that the consumer is doing okay. Are they? Let’s do a bit of a deep dive on the health of the American consumer as of August.
First, our spending on credit DID in fact, go up in June (the most recent number), higher than expected:
However, for the first time in two years, spending on credit cards actually went down. This may be because credit limits are being reached, and interest rates went much higher.
The credit card balance vs. consumer disposable income is far below where they were in 2000 and 2008 when they last recessions occurred, however:
Where we see a big squeeze is in monthly auto loan payment:
And when you add them all up, and add in higher interest rates, you can see the alarming trend in the debt load for the average American family:
What concerns me greatly is how much inflation is impacting what you are getting for your spending. The black line shows consumer credit card usage, which shows us at all-time highs, but when you remove the effects of inflation (the blue line) you can see that the consumer isn’t getting more “stuff” with their cards – they’re just paying a lot more for them:
And perhaps the most alarming thing to me is the Student Loan situation, which is about to come like a wrecking ball back into our economy. This is the total amount of student loans owned (and securitized – meaning – made into bonds for investors to buy). We have nearly $2 TRILLION of student loan debt in America.
With payments scheduled to resume in October, there is growing concern among economists that the consumer is not able to make those payments. We’ve addressed this issue for months here in our blog.
After three years of no payments, most people with student loans long stopped budgeting for those loan payments and just absorbed the debt back into their monthly spending. Now that those payments are becoming necessary again, a large number of borrowers report that they won’t be able to keep the payments up. 80% of people making $50k or less, and fully 65% of people earning $100k or more, will either not be able to make their loan payments, or will have to cut back spending in other areas.
What this means for you
The consumer debt situation was untenable already, but the reintroduction of student loan payments, in our opinion, will be the catalyst that sends our economy from any possibility of a “soft landing” into a full-force recession. We remain strongly convicted to keep our investment models significantly protective and exposed only to the sectors of the economy that you must spend money on during hard times. This remains our conviction.
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
