VTI - 10 Economic Signals Practically Screaming A Recession Is Ahead

2023-09-13 16:35:34 ET

Summary

• The current consensus among economic pundits right now is that 'sticky inflation' will be with us for a while but the economy will achieve a 'soft landing'
• However, that narrative is likely to be wrong on both counts as there are some very negative things happening in the economy right now that too many investors are ignoring.
• Below I highlight 10 economic signals that are practically screaming a recession is the most likely scenario for the U.S. economy over the next 12 months.

The curious mind embraces science; the gifted and sensitive, the arts; the practical, business; the leftover becomes an economist ”? Nassim Nicholas Taleb.

The main economic news that hit the wires on Wednesday was that the August CPI report came in above expectations with a 3.7 reading. This was above expectations of 3.6% and was an acceleration from the 3.2% levels of July. It was the largest month-over-month rise since June of last year. The price of gasoline, which has surged recently, was the biggest contributor to August's increase. " Core" CPI also increased by .3% during the month, above the .2% consensus.

Most economic pundits now currently believe the economy will continue to see ' sticky inflation ' in the coming months and quarters, but the economy will still be able to achieve a " soft landing ."

I believe that consensus is wrong on both counts. There are just too many economic signals practically screaming that recession is likely on the horizon within the next year. Obviously, a significant economic contraction would squash inflation, as it is almost always a deflationary event. In today's article, we look at 10 economic indicators telling investors that not only that recession is a distinct possibility, but it is the probable scenario for the U.S. economy over the next 12 months.

#1

Federal tax receipts through July 31st are down 13% year-over-year. Only eight times since 1960 have federal tax revenues fallen on a y/y basis. Only once have they declined by 7% or more, that was in 2008/2009. This is a key driver of why the deficit this governmental fiscal year will approach $2 trillion. It also makes servicing the existing $32 trillion national debt harder as well. Tuesday, the U.S. Treasury sold $35 billion in 10-year paper. The auction priced at a high yield of 4.289%, up 29bps in the past month, and the highest level since Nov 2007.

#2

Through July, the monthly Leading Economic Indicators have now declined for 16 straight months. The last time the U.S. experienced a decline of at least this duration was in 2007 and 2008.

#3

The yield curve has been inverted since July of last year. At the start of Wednesday, the 10-Year Treasury was yielding 4.3% while the Two-Year Treasury yielded just over five percent. As I noted in my article on Tuesday, monetary policy always acts with a considerable lag. It is historically 18-24 months before the full impacts of a change in the Federal Reserve's monetary policy become fully reflected in the economy.

#4

Small business optimism is tanking. The monthly NFIB Small Business Optimism Index is hovering just above a 90 reading. Only five times has this index been at or below these levels since 1975. In each instance, a recession soon followed. This makes perfect sense given that small businesses create 64% of all jobs in the economy according to the SBA.

#5

Going back to interest rates, the divergence between the average 30-Year mortgage rate and the 10-Year Treasury yield (US10Y) is at extreme levels. In fact, the level of difference has only been seen three times since 1990. Each time, before a pending recession.

#6

According to the Census Bureau’s annual reports on income, poverty and health insurance coverage. U.S. inflation-adjusted household income fell in 2022 by the most in 12 years. The median U.S. income in 2022 was $74,580 compared with $76,330 in 2021. This represents a 2.3% drop. The consumer (70% of all economic activity) has been able to sustain their spending levels due mainly to the huge excess savings accumulating through the massive Covid stimulus bills passed by congress. As can be seen before, those excess savings are now exhausted.

#7

The consumer is hardly the only segment of the economy facing significant challenges. Manufacturing has been in contractionary territory for almost a full year now as monthly PMI readings have been below the key 50 level for 10 straight months now.

#8

The delinquency rate for commercial back mortgage securities just broke through the five percent threshold in August (5.07%) according to Trepp. That is up 40bps from July and a 50% increase in the default rate since the start of the year. This is important, as some $2.5 trillion of CRE debt needs to be rolled over in the next five years. Particularly vulnerable is debt on office buildings given imploding asset values in many parts of the country. I detailed this potential canary in the coal mine recently within my article " Shades of 2007 ."

#9

Housing activity is a key economic driver. Unfortunately, with the recent rise in average mortgage rates to levels not seen since the beginning of this century, housing " affordability" is at all-time lows. Housing activity historically is responsible for between 15% to 18% of overall GDP it should be noted according to the National Association of Home Builders or NAHB .

#10

I will end this piece emphasizing the challenges for the consumer in the United States faces and why consumer spending is likely to be curtailed in coming months and quarters. Just like higher interest rates are ballooning the costs to service federal governmental debt, they are also taking a bigger bite out of consumers' budgets. A situation that only will get worse as the moratorium on student debt repayments ends after a longer than three-year taxpayer financed hiatus.

This also does not bode well given the nation's credit card debt just surpassed the $1 trillion level for the first time.

Given my economic outlook calls for recession over the next 12 months, my portfolio is extremely conservatively positioned with approximately half my holdings in short term treasuries yielding 5.5%. With an economic contraction on the horizon, valuations at extreme levels from a historical perspective, and the Fed Funds rate now north of five percent; it seems the correct and prudent move.

An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today .”? Laurence J. Peter.

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