Author: californiaforecast

Mark Schniepp
September 1, 2023

I wouldn’t say it if I didn’t have the evidence.

The long awaited recession in 2023 is postponed, and perhaps even cancelled.

The GDP estimate for the current quarter (which ends at the end of this month) is currently running at 3.9 percent annualized growth, says Moody’s Analytics.  The Federal Reserve of Atlanta has growth at 5.9 percent for the current quarter through August 24. These rates are quite healthy and entirely unexpected.

These preliminary estimates of GDP growth are based on the most recent incoming data on the economy and to date, there has been strength in a number of indicators:

People filing for unemployment insurance claims remain very low. The unemployment rate remains at a scant 3.8 percent.

Consumer spending remains surprisingly steady. Retail sales posted their fourth consecutive month of healthy growth in July. Orders for goods in general rose sharply in June.

Consumer sentiment, bumping along a record low for the last several months has now meaningfully improved.

Business investment is holding up well. Boeing reported net orders of 200 new aircraft.

Non-residential investment contributed nearly a full percentage point to GDP growth last quarter and it’s still increasing this quarter.

Industrial production reversed its downward trend and came in stronger than expected in July. And even manufacturing improved slightly in August.

Inflation is moderating and there will be disinflation in vehicle prices and housing rents this month.

New residential construction has recently accelerated, and new home sales have increased sharply between February and July. The lack of resale inventory is pushing prospective homebuyers into the new-home market and in turn supporting demand for new construction.

Housing not out of the woods

Soaring mortgage rates and rock-bottom affordability have crushed the demand for houses, but a simultaneous reduction in housing supply has supported prices.

Home prices at the national level climbed nearly a full percent in July (from June), topping their previous peak set a year ago.

We are observing rising home prices in California including the high end coastal areas. Selling values have generally risen in April, May, June, and July this year.

As a seller, we don’t think you’re out of the woods yet. With the rate on the 30-year fixed rate mortgage averaging near 7.5% over the last three weeks and a higher path of rates expected, more potential buyers will  be pushed out of the market.

The housing market will descend further into correction territory due to the significant headwind posed by an unaffordable and overvalued housing market. Prices are currently inflated relative to what economic fundamentals have supported historically. If demand does weaken as expected, prices should be pulled back toward their fundamental values. The outlook expects prices to decline about 5 percent over the next two years. The correction will be less noticeable in severely supply constrained areas.

Wake me up when September ends  (a song by Green Day)

Because that’s when I’ll know the current estimates of growth are real. The economy has proven to be much more robust and resilient than anyone thought this year. The growth estimates are more believable as we see momentum building. While some headwinds still exist, they are fading in many important sectors of economic growth.

The most aggressive Fed tightening in 40 years hasn’t delivered a recession punch to the economy and it appears it just might not. If inflation continues to improve and growth remains steady, we may not see any further rate increases and that will bury the final fears of recession in 2023.

They all lead to more inflation

Mark Schniepp
August 2023

I’ve written about the labor market of California and how there is not much in it this year. While the labor market  has cooled some, it’s still fundamentally strong and by most accounts, workers are fully employed.

Unemployment is still quite low, especially in the coastal counties, and wages for all sectors have risen.  Which leads me to the first symptom: rising wages that contribute to higher inflation for all goods and services.

While wage increase are generally great for workers and households, they further contribute to higher prices in general. This is not a good thing.

A tight labor market may be good for workers, but has a number of direct and indirect effects on inflation, which are significant and not in the best interest of the U.S. or California economy:

Quits by Workers

The monthly frequency of workers quitting their jobs in California has lessened over the last year, but at 350,000 per month, it’s still quite high. Total separations from work which include people quitting, retiring, or getting laid off is over 500,000 per month. And there are still over 1 million job openings in the state that remain unfilled. The high frequency of labor turnover increases recruiting and labor costs for businesses, which contributes to higher wage and product price inflation. Wage inflation is especially high for workers who quit to accept a new job.

Demand for remote working conditions

The high level of quits and unfilled open job positions have combined with worker demands to force employers to allow them to work remotely. This has led to meaningful declines in office demand and rising office building vacancy.  Empty office buildings result in less revenue earned by office building owners. Less revenue translates into lower commercial real estate values which amplify problems when commercial real estate loans require refinancing, especially in the current high interest rate environment.  This is now an expanding and scary issue for regional banks which hold massive amounts of commercial real estate mortgage debt. Refinancing these properties this year and next could potentially lead to a spate of foreclosures if not more bank failures in the state.

Quits and ultimatums by workers for remote setting work have led to worrisome rising vacancy of office space in the major urban markets of California.  Lease space is now extraordinarily high in Los Angeles and San Francisco, exceeding 30 percent.

Labor strikes

International Longshore Workers

The Longshore worker’s dispute lasted from May 2022 through June 2023. It’s still not entirely resolved and it will result in at least 8 to 10 percent wage hikes for dock workers at 29 West Coast ports.

Cargo volumes coming into the Ports of Los Angeles and Long Beach were diverted through the Panama Canal to east cost ports over the last year. This results in higher shipping costs and higher prices for imported goods.

Writers and Actors

The Writer’s Guild of American strike began on May 1. The Hollywood Actors strike commenced on July 17.   This is the first time that both the WGA and SAG have been on strike against the Alliance of Motion Picture and Television Producers at the same time since 1960, making it an unprecedented one. The WGA demands increased minimum compensation in all areas of media, and increased pension and health plans, and more. SAG is asking for an 11 percent increase in the minimum basic agreement this year, and 4 percent per year going forward. Actors also demand increased residual payments for film and TV.

Hotel Workers

Hotel workers have been striking and demanding higher wages and other benefits as they argue their existing salaries are unsustainable amid the region’s high cost of living, or more specifically, the cost of rental housing. The latest strikes are the largest that have been authorized in recent years in the hotel industry.

Unite Here Local 11, representing 32,000 hospitality workers across Southern California has coordinated a number of multi-day strikes in July impacting many hotels in Los Angeles and Orange County.

The union has been in contract negotiations since April. It demands an immediate $5 per hour wage bump and $3/hour annual increases over the next 2 years, health benefits and a pension.

Strikes in general disrupt services and frequently the provision of goods. However, and as we all know, higher wages compensate us, but contribute to rising prices for all goods and services that we as consumers must ultimately pay. And this leads to higher stubborn core inflation due to rising labor costs. While the headline inflation has now fallen to 3.0 percent, core is inflation is still at an unacceptable rate of 4.8 percent, more than twice the Fed’s target rate.

I’m not against fair labor contracts or fair wage levels for workers in any industry, but when there is an avalanche of  labor market disputes, this leads to the likelihood of meaningful increases in wages and ultimately prices of everyday goods which collectively make everyone worse off.

Amid rising labor costs, employers seek ways to reduce staffing, typically through automation. The onset of ChatGPT, other “generative AI” software for transforming the workplace, and robots will enable firms to ultimately displace workers in many fields, including the ones now in labor disputes seeking higher levels of remuneration.

A Mid-Year Assessment

Mark Schniepp
July 8, 2023

Fortunately, current conditions are not yet supporting the widespread expectation of inevitable recession this year.

Back on March 27, the majority of economists forecast a U.S. recession in 2023, and for many good reasons. And while the economic clouds are darkening . . .there’s no storm yet.

The sharpest increase in interest rates in 40 years, the excessively inverted yield curve, growing more excessive by the week, and the dismal ratings in American polls regarding government leadership and the direction of the country have not tipped over the U.S. economy.

The Recent Evidence

The financial market indices are all higher during the first half of the year. The laggard is the Dow Jones Industrial Average, ahead by just 2.4 percent year-to-date. The S&P 500 index is up 15 percent and the Nasdaq Composite is soaring, up 31 percent.  The bull market in stocks is now about 9 months old.  Global economic  conditions are improving.

Surprisingly, despite mortgage rates hovering near their peak for the cycle, new home sales were higher in May.  Recent price declines have helped to increase sales. But now even home prices are reversing again, with a number of price indices rising in March, April and May.

Fed chair Jerome Powell said last week that he expects further interest rate increases, consistent with the assessment of his fellow policymakers at the June meeting of the Federal Open Market Committee.  We are very likely to see another hike in July.

Even absent more rate hikes, there is little doubt that recessionary risks have risen this year, and they will continue to haunt the economy for the rest of 2023. But as they do, firms continue to hire, households continue to spend, and the economy continues to grow.

The current level of consumer pessimism is consistent with past periods of economic recession, but that pessimism Is not deepening. . . . . . In fact, the consumer sentiment index rose 5 points in June and is 14 points higher than a year ago.  The labor market’s persistent strength is an encouraging sign that is leading to an uptick in optimism.

The GDPNOW estimate is running at 1.9 percent for quarter 2 which just ended.

The Atlanta Federal Reserve estimates GDP growth for the contemporaneous quarter, based on the economic indicator reports coming in daily.

We’ve had two positive growth quarters this year so far (both at about 2.0 percent), with some momentum building as we head into Q3. Inflation reports have consistently been lower every month for a year now.

Manufacturing indicators are mixed, so we can’t draw too many conclusions from that. Actual production has been contracting, but new orders for manufactured goods are rising. And business investment in both structures and equipment rose in the 2^nd quarter, contributing about half of the positive growth in GDP for Q2.

While most economists have stubbornly not changed their position on recession in 2023, consumer expectations of recession significantly reversed in June, though their spending has become more cautious.

We expect real consumer spending growth to remain modest through the summer and then slowly gather momentum. On the plus side, the few remaining drags from supply constraints will lessen, inflation will continue to slow, and jobs will remain plentiful.

Despite many of the indicators moving in the right direction, admittedly, job growth is slowing, the level of inflation still remains high, wage growth has slowed, and household savings are being drawn down further. Real consumer spending rose 2.7% in 2022, and will grow less than 2 percent in 2023. But the fact that it is still growing is one of the more encouraging signs that a soft landing this year is not a remote possibility.

Summary

This mid-year assessment reports that the economy has heroically avoided recession so far, and that there is a rising chance that recession could be averted in 2023.  The strong indicators in the economy remain mostly unchanged, and many of the weak indicators are actually improving.

But we are not out of the woods.  Two more rate hikes threatened by the Fed could be a tipping point. Issues with the leadership of the nation are starting to take center stage in the news—including the fringe, the fake and the mainstream media. Depending on what transpires this summer, potential revelations could rally businesses and consumers or shock them.

That said, we don’t expect much overall improvement in the economy until late 2024 or early 2025 when interest rates will be in decline, the housing sector will have turned around, and inflation should have returned to the longer run average.

Mark Schniepp
June 2023

“Default could trigger a spike in interest rates, a steep drop in stock prices and other financial turmoil. Our current economic recovery would reverse into recession, with billions of dollars of growth and millions of jobs lost.”

                                  — Janet Yellen, Secretary, U.S. Treasury, January 15, 2023

Through June 11, the Federal government has received $2.994 trillion in revenue for fiscal year 2023. And through June 11, the Federal Government has spent $4.149 trillion for fiscal year 2023.  We continue to outspend our revenues and have for the last 22 consecutive years. This is how we always run up against the debt limit that is set by Congress every few years to enable more spending.  Our national debt is now at $31.8 trillion as of June 2023.

The President and Speaker McCarthy just agreed on a resolution for the debt limit: to suspend it until 2025, and enable spending to continue and current obligations by the federal government to be paid on time.

The debt limit or ceiling is the maximum amount of money that the United States can borrow cumulatively by issuing bonds.

When the debt of the U.S. government  bumps up against the ceiling, then the Treasury Department must resort to “extraordinary measures” to pay government obligations and expenditures until the ceiling is raised again so more borrowing can ensue. Extraordinary measures (which are not that extraordinary) have been in place since January 19, 2023 when the ceiling of $31.4 trillion was reached.

The worst case scenario by the U.S. government is a default on its secured debt.

So this is the issue our Treasury Secretary isn’t explaining. Default is the inability of the U.S. government to make required interest and principal payments on secured debt:  treasury bonds and bills that have been issued over time.

A default does NOT occur if the federal government can’t make all its payments, such as pension contributions every month to federal workers, or aid to Ethiopia, or finance military arms or other resources going to Ukraine, or keep the postal service running 7 days a week.

There is so much that the federal government can suspend or delay in terms of monthly expenditures in order to keep the debt ceiling from being breached.

There is enough revenue that is received by the Federal Government each month to fund interest payments to holders of government securities, and/or to redeem bonds or bills that mature.  So in order to avoid a default, the U.S. Treasury would shift money around to keep paying interest on Treasuries. A default is not going to occur in June as they intimated could occur.  Nor would it occur in July, August, or September, and likely not in October or November for that matter.

Other impacts that might occur (and that we are being threatened with) as a result of this shifting are only speculative, and largely without precedent.

There have been a number of showdowns over the debt ceiling in Congress since 2011, some of which have led to partial government shutdowns, such as temporary or partial closures of national parks, reducing the number of delivery days for mail, or a furloughing of federal workers in some departments.  But chaos and calamity was always averted, despite dyer threats of such outcomes.

The Treasury can always prioritize payments. And like you if your revenues were to fall short of your monthly liabilities, the Treasury can always call their vendors and ask to extend their payment schedule until revenues increase or the debt ceiling limit is ultimately raised.  A creative U.S. Treasury can work tough times out, providing everyone ultimately gets paid.

Furthermore, Congress can always “claw back” appropriated obligations that haven’t been spent yet, reducing overall debt.  This is what the House wanted to do with unspent COVID-19 appropriations. They achieved some of this regarding unspent pandemic relief payments and also regarding the funding of 87,000 new IRS agents that was appropriated by Congress last August as part of the Inflation Reduction Act.

More claw backs are possible; they are just not politically desirable. But neither is default. Clearly, Congress should be more accountable for their spending behavior as to how it will impact the debt ceiling.  This is what you as a household would do when you are faced with credit card limits and knowledge of your revenue flow from month to month.

We would not have defaulted this month as we were warned. This is all part of a game of chicken that the branches of government play to get the other side to cave.

Payments would have been prioritized and/or delayed, some government functions would have been temporarily suspended, and some of the funding obligated as part of the trillions of dollars of spending bills authorized by Congress since 2021 could have been clawed back.  This is how businesses and households run, and this is how we should expect the Federal Government to run when faced with a budget crisis.

Had we seen this playout, I believe Americans would have been encouraged by creative action rather than rhetorical statements by the Federal Government to address the spending limit, and capital markets would likely be more supportive of any semblance of genuine fiscal restraint.

Mark Schniepp
May 2023

Where We Are Now

To review, in 2022 inflation soared to the highest level since 1982, remaining elevated since the peak month of June but improving nevertheless.

We are now in a period of disinflation. Or declining inflation. Prices are still rising for most goods, but the pace of price increases for the composite of goods and services is slowing down.

That still means you are paying more for goods (and services) and are stuck with higher prices for many everyday goods. While the price of some goods and services will reverse (as it has for used cars), others will not,  even as the rate of inflation is normalized.  And “normalized” is moving back to under 4.0 percent and even lower by the end of this year.

For the level of prices to return to 2020 levels, we would need to see general price deflation, a rare and unlikely occurrence, sometimes emerging during a recessionary cycle.

Home Prices

The rise in the cost of housing has clearly abated over the last 12 months. Both selling values for purchased homes, and monthly rents for apartments have declined or leveled off. The housing price and rental price indices that feed into the general price level are still rising, because they are measured with a lag.

Home prices peaked last April or May of 2022, and they declined every month into November or December. For many regions, they have started to rise again especially as the season for home buying arrives.

The median price in Orange County fell 15 percent from April 2022 to November. Since December and counting March 2023, the median selling value has rebounded 12 percent.

Selling values are also rising in Riverside County, Ventura County, and San Diego County.

The increase in average monthly rental prices has also cooled throughout California, with prices moderating or weakening in most counties.

Labor Markets and Inflation

The unemployment rate is 3.4 percent, which by all accounts still implies a tight labor market. Year over year wage growth is 6.1 percent (through April). This is much higher than it needs to be to contain inflation.  So while the general CPI report is in decline, one of the key underlying components is still running relatively high. If this persists, inflation will unlikely be contained below 4 percent.

A principal reason for the sharp inflation in wages is the high number of job quitters. Inflation in wages is much higher for people who switch jobs, or workers who quit a job and become re-employed elsewhere.  As long as quits remain high, so will wage inflation, prolonging general price inflation, and the rising probability of stagflation.

Can We Avert Stagflation ?

I’ve been warning about stagflation for over a year now.  Stagflation is very slow, no, or negative growth combined with Inflation. It’s one of the hardest economic maladies to cure because Keynesian remedies won’t work, and monetary remedies won’t work.

The way to avert stagflation is to rapidly and if possible, gingerly correct the inflationary environment without tipping the economy into rising unemployment and falling consumer demand, or in other words, a recession.

With an inverted yield curve of the current magnitude, and with the index of leading indicators sliding for the last 10 consecutive months, the onset of recession appears inevitable.

Growth is still positive today and has been for nearly a year but the level of growth has moderated. Combined with current inflation, a period “quasi-stagflation” has been present for the last year. Moving into a bona fide recession–meaning negative GDP growth, rising unemployment and diminishing utilization of our factories—then declining demand for products and services will hasten, and producers will cut prices to either move rising inventories of goods that are not selling, or to produce and sell goods to consumers to stay in business.

Inflation will likely fall more precipitously if an old fashioned recession is clearly manifested. To date, GDP growth is NOT negative, unemployment is NOT rising, and factory utilization remains fairly strong.  So we can’t yet count on a recession to clear out current inflation, nor do we want one because the human misery is likely to be worse.

The Fed just raised rates, hopefully for the final time during this cycle. Now we wait and see how inflation responds over the next 2 or 3 months. If labor markets loosen up enough to keep workers from quitting and demanding higher wages, and if home prices level off, then those are two components of the general price level that will largely help to control inflation.

Mark Schniepp
April 11, 2023

The Chicken Little contingency is suggesting that the market and home prices are in a bubble-like condition, similar to 2008. There are a couple of very sound reasons why this will not take place.  In 2008, low teaser mortgage rates required refinancing within 2-5 years. As rates increased, owners were forced to basically either abandon their properties to the banks or face foreclosure. They did not have equity in their homes, meaning there was nothing to protect. With negative equity, walking away was easy. Not so today.
— Chuck Lech, The Lech Report, March 6, 2023

During the housing bubble years of 2003-2007 which precipitated the Great Recession, the era of short term, variable rate, easy-to-qualify-for-mortgages has largely been replaced by down payments of 20 percent, and 30-year fixed mortgages with rigorous income verification. Most homeowners today have built up equity in their homes, have low interest rate mortgages and only one mortgage, and do not need to re-finance.

The housing market is now in recession as housing bears the impact of increased interest rates. Sales are off 40 percent and home prices are retreating again, but not like in 2008 or 2009 when values declined 30 to 60 percent across California.

The Price Correction to Date

To date, the median price for a home in California has declined 18 percent from the peak month for selling value, which was May 2022. The Los Angeles County reported median selling price is 15.5 percent off the peak. And the San Francisco Bay Area median has plunged 35 percent.

However, confusing these reported price declines is the composition of homes that are selling. Currently, more lower priced homes are closing escrows relative to the sales mix in 2020, 2021, or early 2022. A mix of sales with a higher concentration of lower priced homes reduces the median price, but does not necessarily reduce the value of real estate proportionately.

Holding constant the sales mix (or the quality/size/location of the home), and evaluating how prices are actually declining for the asset, we turn to the Case Shiller housing index which espouses to track actual real estate values nationally and over time.

For the 20 largest cities combined, the price index is off only 5 percent from the peak in May 2022 to February 2023.

For the Los Angeles area, the index has declined 6.4 percent and San Diego County is down 8.3 percent. San Francisco shows the most severe price correction to date at 13.2 percent, not 35 percent as the California Association of Realtors reports. It should be noted that soaring price appreciation during the 2019 to 2021 period was more prevalent in the Bay Area than any other region of California. But now, with residents departing the Bay area in droves to Sacramento and the San Joaquin Valley, home prices are adjusting downward as a result of diminishing demand.

In 2009, the total decline in the Case Shiller price index for the Los Angeles Metro area was 41 percent. To date, it is off less than 7 percent. Consequently, we have a long way to go for price declines to match the trauma of the Great Recession.

It’s Actually Different This Time

Realistically, the pace of the rise in prices at 20 plus percent per year was unsustainable. The markets from late 2020 through the first half of 2022 were similar to what happened just ahead of the Great Recession when home prices were accelerating at a similar pace. But other than for that, today’s market is quite dissimilar from the bubble days of 2005-2007. Consider the following:

1. In 2006, the percent of California buyers with no down payment was 21 percent. Today, it is less than 3 percent.
2. The percentage of home buyers who purchased with a second mortgage was 43 percent in 2006. Today it is less than 2 percent.
3. Adjustable rate mortgages accounted for 33 percent of all purchases in 2006. Today they account for 2 percent.
4. There are nearly twice as many all-cash buyers today than in 2006.
5. Lending criteria are much stricter today and have not loosened up much since the abuses during the bubble years. A buyer needs to have a down payment, verifiable income, and a minimum credit score that is higher today than in 2006.

A Welcome Change

Not only the slowing of home price growth but a reversal of home prices is actually a welcome change to the market because it will bring more balance to the transaction between buyers and sellers, resulting in healthier housing market conditions. It will also increase the affordability of homes in California, expanding the domain of potential buyers who might otherwise defect from the state. This has been the circumstance currently driving the substantial volumes of out-migration in 2021 and 2022.

Vulnerabilities

 A looming vulnerability is rising household debt. If the impending recession unleashes unexpected trauma in the labor markets, workers become unemployed and their household debt levels would rise along with the likelihood of home foreclosures.

The onset of foreclosures would increase housing supply, amid rapidly evaporating demand, and crash home prices further. This could spiral out of control as it did in 2008 and 2009.

Layoffs would have to become pervasive leading to rising unemployment, other than just prevalent leading to a rapid rehire as they are today.  The risk is there but it’s low, as most economists expect a mild recession with very little attendant labor market calamity.

Mark Schniepp
March 3, 2023

Layoffs

Job cut announcements from U.S.-based employers surged to start the new year, hitting the highest January total since 2009. Job cut announcements in the first month of 2023 totaled 103,000, a worrisome 136 percent from the volume of cuts announced in December.¹ The number of technology company layoffs accounted for 41 percent of the January total, representing the lion’s share of announced job cuts.

The website Layoffs.fyi tracks the announced layoffs by companies world wide since the onset of the pandemic in 2020.  During 2022, the site reported 1,046 tech company announcements totaling 161,061 layoffs. For January and February 2023, total announcements from 411 tech companies report 118,726 layoffs. This shows that the pace has exponentially accelerated.

These signs clearly signal a weakening job market at the end of 2022 and certainly in 2023.

However

U.S. claims for unemployment insurance declined again, in the 3 weeks ending February 11, 18, and 25. The level is below 200,000. The average weekly level since 2010 and excluding the pandemic is 256,000. Claims are providing us no indication that the labor market, seemingly traumatized by the unrelenting surge of layoff announcements since the Spring of 2022, is actually weakening.

The unemployment rate fell to 3.4 percent in January—the lowest level since 1969—also giving us no indication that the layoffs are resulting in unemployed workers.

Furthermore, unfilled job openings rose in January to over 11 million again. The help wanted adds online are also near their all-time highs in numbers. Although it is so much easier for employers to post job openings today versus 3 or more years ago, which makes this data series comparatively less reliable, the levels are still an indication of an extremely tight labor market.

If the traditional labor market indicators are all signaling a fully employed labor force, then labor resources are not idle and therefore unused, normally a requirement for recession. It is true that unemployment is a lagging indicator and not one that I would use to predict a recession. But to have a recession, we need rising unemployment, and we don’t see any of that yet.

Then what about the layoffs?  Why aren’t we seeing them in the data ?  Why aren’t laid off workers claiming unemployment benefits?  Why isn’t the unemployment rate rising ?

The health of the Labor market is not in doubt. While unemployment claims can turn on a dime, why haven’t they as layoffs have been piling up over the last 6 months ?

Answers

The data support two answers.

• It is likely that laid off employees are getting rehired rapidly, avoiding the need to claim unemployment benefits and avoiding the unemployment rate. When the job openings data is factored in, which indicates that the need for employers to fill jobs remains near record levels, and the number of monthly hires is still north of 6 million, then absorption by companies of laid off workers is the most probable explanation.

• The number of new business formations remains at very high levels, month after month. And this has been the story since the pandemic. Business formations in California are running over 40,000 per month since mid-2020. Prior to 2018, they never eclipsed 30,000 averaging 25,000 per month since 2006.  Business formations require employees and laid off workers are often absorbed by start-ups, or they become gig workers who contract to new business start-ups.

The big story that we will continue to monitor is whether the unrelenting layoff announcements will ultimately translate into higher jobless claims and a higher unemployment rate. To date, we don’t see it.

1 These reports come from Challenger, Gray and Christmas who have been tracking U.S. company layoffs and hires for 50 years.

Mark Schniepp
February 7, 2023

Arguably, the current U.S. labor market is the tightest it has ever been. The rate of unemployment has been under 4.0 for the last 12 months, and it continues to drift lower. It’s now at a 54 year low.

We had a notion that the labor market might be slowing, and that job openings were starting to abate. Instead, they are rising again. There are nearly two unfilled positions for every person unemployed.

The number of job openings remains a problem for employers trying to fill positions and provide a seamless flow of goods and services. So far into 2023, there is nothing seamless about that flow. Project shortages abound, and we are all annoyed while trying to get accustomed to waiting longer for services.

The lack of available workers is the issue. We thought by now the labor market would soften and job openings would largely fill or be withdrawn as a result of a slowing economy.

Six months ago, in the August 2022 newsletter, I wrote:

To be clear, the economy is not in a recession, but the likelihood of recession during the current business cycle is virtually certain. How severe and miserable the recession will be cannot yet be predicted, although there is no absence of opinions about this.

What Recession Usually Means

1. 1. Substantial job losses and even mass layoffs
   2. Businesses shutting down
   3. Private sector activity showing considerable weakness
   4. Household budgets under severe strain
   5. Broad-based weakening of the economy

Today, I’m not so sure that recession is virtually certain. That checklist is still valid, and we still don’t see any evidence of (A) or (B), or (D).  We do see evidence of (C) and a broad-based weakening of the economy is the subject of everyday debate, because, well, the signals are quite mixed.

The Ugly

While household debt is still low, rising credit card balances are growing more worrisome, which could ultimately strain household budgets that don’t have much room for error. The personal savings rate has plummeted to the 2^nd lowest level in 50 years.

Everyone is working, but everyone seems to be spending the same or more, due principally to the inflated prices we all face today.

Considerable weakness can be seen in the ISM Manufacturer’s Index which monitors the demand for U.S. manufacturing products. It has generally been in decline for the last 14 months. The recent movement below 50 indicates contraction and trouble for the industry.

Consumer sentiment remains pessimistic, and is not getting much better. Most Americans believe the direction of the country is abysmal. The index of leading indicators has recorded 10 consecutive months of decline.

And of course, the housing market is already in a recession.

On The Other Hand

The XRT index has soared year-to-date, the inflation reports are showing improvement, the Nasdaq composite index is up 15 percent year-to-date, the non-manufacturing index rebounded sharply in January as new orders surged.

The XRT fund tracks the performance of the S&P Retail Select Industry Index. From January 1, 2023 to February 3, 2023, the fund is up 21.7 percent.

The certainty of recession is fading because the labor markets are not weakening, and consumers continue to spend despite a decline in their real incomes. Their savings are depleted but their debt levels while rising on revolving credit cards, are not increasing much otherwise, largely because their mortgage payments are contained by low fixed rate loans they refinanced into over the last decade. Though revolving credit is elevated and rising, it is not raising any major red flags by itself.

Stock Market

Is what we are seeing from the stock market year-to-date a dead cat bounce?  We can’t say. The Nasdaq lost 33 percent last year, the S&P was off 19 percent, and bond prices tumbled 17 percent, generating one of the worst years for investors on record.

History does tend to show that stock market rebounds follow big stock market drops. Investors may be anticipating this until the earnings reports suggest otherwise. Earnings rise when profits rise. Profits rise with economic growth. It’s the growth issue that we are debating here. Sorry, but we don’t know yet because, well, the signals are all mixed up.

Verdict: Recession in 2023?

Recession in quarter 2 is what we had anticipated. Because of the strong labor market, a weakening there will probably not occur until the 2^nd half of 2023, delaying the likelihood of recession to later in the year. There is also a rising probability that the nation might skirt past a bona fide recession this year, depending largely on what happens in Europe and China.

The projection for economic growth in 2023 is still weak, but recession is less certain because of improvements on the inflation front, and the recent decline in mortgage rates despite the FED’s stance that further interest rate hikes this year are appropriate.

I will keep you posted every month on how conditions are changing, for good or bad. So stay tuned.

By Mark Schniepp
January 6, 2023

No Surprise

It’s not much news to anyone to declare that housing is in a recession. In fact, it’s been widely reported as a fact, even though there is no bona fide arbiter of such a call. You know a recession when you see it or feel it.  Prices still remain high, but sales of existing homes in California are off 35 percent since July. And selling values are now following though they are unlikely to decline proportionately.

Despite (1) recent decreases in mortgage rates and (2) falling home prices, pending home sales are falling rapidly. Monthly mortgage payments remain high relative to incomes. This is keeping buyers, especially first-time home buyers, on the sidelines. Furthermore, homeowners  who had intentions to sell, are reluctant to list their homes for sale after having locked in record-low interest rates during the pandemic.

The stalemate between buyers and sellers will continue as long as the Federal Reserve keeps monetary policy tight and the prospects for a general recession remain uncomfortably high.

New Homes and the Sentiment of Builders

The Housing Market Index, a closely watched industry metric that gauges the outlook for home sales, declined to 33 in November on a hundred-point scale, the lowest level in a decade (excluding the April-May 2020 lockdown period). The higher the index, the more optimistic builders are regarding housing market conditions, and conversely.

The NAHB/Wells Fargo Housing Market Index is based on a monthly survey of National Association of Home Builder members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes.

Sales, housing starts, inventory, and the direction of prices all point to additional stress for the first half of 2023, though there is some glimmer of hope regarding the movement in mortgage rates. The interest rate on a 30-year fixed rate mortgage fell to 6.3 percent during the week of December 20^th, after peaking at 7.1 percent in October.  It is currently hovering around 6.5 percent.

Mortgage Rates

The next Federal Reserve Open Market Committee meeting (where interest rate policy is enacted) is more than a month away. More evidence on how inflation is being tamed will be out next week. Will the Fed hike the fed funds rate 50 basis points or just 25 at the next meeting? It will depend on the December CPI report due out next week and other indicators that directly or tangentially contribute to inflation.

Either way, there is no doubt that the economy is slowing and a recession is likely.

A more general recession would intensify the housing downturn. This is because household incomes frequently decline in a recession, and adjusted for inflation, they are declining now.

Demand Impact of Higher Interest Rates

The Fed initially starting raising interest rates, in part, to seed a “correction” in an overheated housing market. Home prices rose more than 40 percent from the beginning of 2020 to June 2022.

At a 5.8 percent interest rate, a prospective buyer with a $2,500 monthly budget could afford a $406,250 home. At a 6.5 percent rate, the same buyer could spend only $383,750. Just a year ago, with a 3 percent rate, the buyer could spend $517,000.

The Case-Shiller Housing Price Index adjusts for the mix of housing that is selling. Higher end homes tend to sell less frequently and are subject to a larger price adjustment. Affordable home prices will adjust less because they are in greater demand. Home prices are clearly in decline and have been since the spring of 2022. All housing price measures are demonstrating contraction, including the Case-Shiller index.

Real Estate Related Employment

 Surprisingly, despite the precipitous fall in home sales, the real estate recession does not appear to be affecting direct real estate sales employment in California. Well, at least not yet. Now it’s true that real estate brokers and agents are largely self-employed and do not show up in the W-2 employee counts. But the number of agents still tend to move in tandem with W-2 employees within broker offices, and the evidence does not indicate any contraction there. That’s not to say however that the current level of residential real estate business has not impacted many sales agents in real estate.

Where there is clear contraction is in the mortgage lending sector, because lending has all but dried up. Job counts have been in decline since April of 2021,  though they are curiously still higher than at anytime during 2019.

The predicted trajectory of real estate for the next 6 months is a continuation of the last 6 months. The first half of 2023 will be a difficult period, but not just for real estate.  There is now evidence that employment in manufacturing has turned down.  I can’t see any other significant weakness however.  In general, labor markets are unequivocally strong at the start of the new year.

By Mark Schniepp
December 3, 2022

Understanding the Current Environment

The first step in updating your business plans for 2023 is understanding the current and likely direction of the economic environment.  Know where you stand currently and where the business is likely to be by say, June of next year.

Are your clients exporters?  Are you an exporter?

Exports are forecast to slow way down due to clearly slowing global demand.

Are your clients domestic consumers? 

Higher prices for goods and services will slow down the pace at which consumers will buy goods and services, along with a pullback in spending due to uncertainty and a lower valued stock market.

Is your client the government?

State and local governments will remain fairly autonomous and in a position to maintain their fiscal budgets which generally end on June 30, 2022. Austerity will likely set in during fiscal 2024.  The GOP led House of Representatives is likely to fiscally restrain the federal government starting January 3, 2023.

Is your client age-dependent?

Millennials are working and will likely stay employed and demanding the kinds of goods and services that they buy. Gen Z is part of the entry level workforce or graduating from colleges and universities. They will be vulnerable to layoffs and some might struggle to find employment.

Boomers are retiring in a rapidly growing wave that started in 2020. In 2023 and 2024, we will see the largest waves of Boomers turn 65. An estimated 36 percent will not retire and elect to remain in the workforce. Nevertheless, expect many of the senior people in your workforce to retire and require replacements.  This will lighten your healthcare expenses but could increase your recruiting expenses.

Today’s Environment

The current estimate for how GDP is tracking in the 4^th quarter ranges from 2.2 to 2.8 percent growth, annualized. Consequently, providing the November and December data don’t significantly deteriorate, calendar 2022 will wind up with both positive and meaningful growth over the last 6 months.

For many businesses including retailers, “adequate” revenue growth will likely finish out the year despite significant talk of recession and struggle.

Job growth, nominal income growth and a rise in real inflation adjusted consumer buying has powered the economy forward during 2022.  But conditions are changing.

Headwinds into 2023

High profile layoff announcements are starting to pile up though you don’t see any evidence of that yet in the unemployment rate.  But layoffs are coming, and the record number of job openings present in the economy will shrink from 11 million to 6 million over the next four to six months.

Manufacturing is now facing significant challenges as 2023 approaches. High producer prices, rising interest rates, and supply-chain issues are the headwinds here. Deteriorating business confidence is another key concern. Expectations can turn on a dime, but the increasingly pessimistic outlook among businesses does not bode well for the near-term prospects.

So far, manufacturing reports have managed to stay positive.  New orders however are contracting.  And expectations gleaned from surveys indicate a significant drop in both current and future expenditures on product inventories.

And this is occurring as manufacturers monitor potential consumer demand for, in particular, larger durable manufactured goods, including furniture, appliances, vehicles, and electronics.

The housing market has cooled off, needless to say.  Both existing home sales and new home sales are below their pre-pandemic levels now.  If your business relies on real estate, 2023 will be tough because mortgage rates will remain high and the risk of declining real incomes is high.

The interest on the 30-year fixed mortgage rate has backed off a bit from its peak of more than 7 percent, but the rate has effectively doubled since the start of the year. Buyers are priced out of the market and will have to delay their jump into homeownership.

However, many buyers will still be looking for ways to buy homes so creative financing arrangements should work to sell homes in 2023.

Real estate will look better on the back end of 2023, or after the traditional buying season is over. Why? Because the business cycle bottom may be occurring at that point. Perceived bottoms are the start of stock market rallies, and there will be bargain-hunting buyers for all assets. So be prepared for when the darkest hours approach.

Pessimism among Consumers

Consumer sentiment from surveys is currently at levels that are consistent with a bona fide recessionary environment. The American consumer is clearly frustrated with high gasoline prices, the steep decline in stock values, and on-again off-again shortages of goods.  The high levels of inflation are leaving real household incomes lower than were they were a year ago.

Compared to last year, consumers will spend as much this Christmas but receive less. That means businesses will sell less product, while facing higher costs. Consequently, there is a greater likelihood of a lower net income holiday season for retailers that disproportionately rely on the holiday season.

January and February will also remain slow because U.S. export markets will be impacted by recessions in Europe and in China.

The most encouraging component of business confidence surveys are the responses about the company’s hiring intentions. Few businesses are laying off. Businesses realize that they will have a perennial problem filling open job positions as baby boomers age out of the workforce, and not enough of generation Z will enter the labor force.

That said, intentions by businesses to invest in further equipment and software remain favorable in preparation for the potential inability to fill all job positions.

Planning

Inflation has peaked though it remains uncomfortably high at nearly 8 percent.  Households would be spending on average, $433 more per month if they were to buy the same goods and services as they did in 2021.  However, they aren’t doing this because they can substitute into lower priced items or postpone buying them for now.  This means lower demand in general for products and services. This this could very well be your product or service.

Therefore, be ready for a year in which you anticipate and can therefore plan for lower demand. Unlike the last two recessions (in 2008 and 2020) in which businesses were largely ambushed, you now have lead warning that conditions will weaken into 2023.

You can expect to need fewer workers which is usually the largest business cost you incur.  If you’ve invested wisely in 2022, your automated functions are running efficiently and you can probably delay filing job vacancies.

Watch the monthly labor market reports for early clues on the direction of the economy. Unemployment is currently 3.7 percent. Job creation is around 250,000 per month. An upward trajectory in the former and/or a downward trajectory in the latter represents the weakening that we are forecasting.

Watch the bond market. The inverted yield curve would have righted itself and the spreads between short and longer term yields will be widening, suggesting the end of contraction.

Watch the stock market. A sharp upward movement lasting more than a few weeks would be an indication that the bear market has reversed and the market is projecting rising growth 6 months hence.