The Gloom and Doom News That You’ve All Been Waiting For: The headline to this section is very similar to many headlines that have been coming out over the last few weeks. According to data compiled by the Wall Street Journal, news outlets all over the world are producing economic/business news pieces with a tone so negative it is generally reserved for recessions. Globally, optimism peaked somewhere in early 2018 and has been on a step decline since then. As if on cue, at the end of August/beginning of September the word “recession” slipped its way into the mainstream lexicon again, and its use has accelerated since then. The global ramifications of this trend lend themselves to trade (or the lack thereof) being the main explanation for the negative sentiment. In a poll conducted by The Economist, uncertainty around trade has spiked dramatically in every developed country and most notably in the United States, Canada, Mexico, and China. The trend is also captured in the CPB World Trade Monitor data which indicates cross border trade is falling at its fastest rate since the last recession.
Our Takeaways: Most news outlets, both financial/business and general, have dedicated some time during September speculating on a "pending recession" or "recession fears." If this recession does end up happening within the next 3 to 14 months, it will probably go down as the most widely anticipated and thoroughly prognosticated recession in history. Two likely avenues from here: 1) "We" talk ourselves into a recession (this is already showing up in CEO/CFO sentiment, Cap. Ex. future expenditure, future purchasing/ordering, future hiring expectations) through more conservative corporate actions/decreased consumption, increased savings on the consumer side; or 2) The heightened focus on recessionary triggers creates a healthy moderation to any excesses staving off a recession for a few more years. Right now, it looks like option #2 is slightly more likely than option #1 at the moment - at least as far as the U.S. is concerned. Governments and central banks around the world are all clearly signalling at the moment they are ready to step up and do whatever it takes to keep this expansion running. The breakdown is likely to occur only if/when these institutions start hitting practical limits in their ability to influence and support markets. There is some sign this could already be the case with the breakdown between QE measures enacted be the Fed and stagnant interest rates, but we will need a few more quarters of data before this can be confirmed.
Hot and Cold Job Market: On September 10th, the Wall Street Journal ran an article that said in part “the number of job openings decreased in July from a year earlier for the second consecutive month, underscoring slowing demand for new workers...” A day later Axios reported “just this week, Amazon, Target and Wendy's have announced plans to hire a combined 180,000 new workers or temps, adding to the swelling number of jobs that so far outpaces the number of people who are available to work...” Both articles went on to paint very different pictures of the current job market and the implications for some of the supply and demand imbalances we are seeing. The WSJ article spent time analyzing the meaning and potential effects of continued decreases in job openings ultimately concluding that, while an extended downturn would be problematic for the economy, there is still some runway given the number of surplus open positions (as measured by current openings minus the number of unemployed people in the workforce). One upbeat item the WSJ article touched on was the increases we are starting to see in wages which has gone from relatively flat (since the Global Financial Crisis or “GFC”) to about 3% YoY for almost the past year. The Axios article struck a more upbeat tone focusing on specific announcements from three large retailers: Amazon, Target, and Wendy’s who have all made announcements recently that they plan to make significant increases in their hiring. Amazon has a company record of 30,000 open jobs that it is trying to fill before the beginning of next year. Wendy’s is trying to add an additional 20,000 staff to meet the extra shifts it anticipates from rolling out its breakfast menu and shifts. Target, who already employees about 360,000 people, is looking to bring on about 100,000 additional, temporary workers for this holiday season.
Our Takeaways: These two articles encapsulate what is so difficult about today’s market environment. Both publications typically have a fairly neutral, fact based approach to reporting economic news, but with the data available about the current market it is fairly easy to construct very divergent narratives. However, the WSJ article struck tones we found slightly more relevant. For instance, stepping back and looking at the overall trend in the demand for labor shows a decline. This trend has been persistent through September with openings continuing to decline. It is unclear at this point if this pull back is for economic reasons (i.e. companies are not expecting to need as many workers) or if they are for practical ones (i.e. previously unfilled/unfillable jobs are being pulled off the market. In either scenario, this is not a small piece of the puzzle. The U.S. labor force (employed and unemployed people) is about 160 million, and job openings currently sit around 7.2 million or 4.5% of the workforce. Even hypothetically, if you were to match all of the unemployed workers to open jobs, then you would still be left with excess openings of about 1.2 million which is almost 1% of the total workforce. At an average annual income per capita of $48,150, these 1.2 million jobs represent about $57.8 billion annually in consumer purchasing power that does not have anyway of being realized. Another key point the WSJ article touched on was the increase in wages. This is one key area that has been absent in this expansion. The rate of wage increases is going to be a key area to watch over the next few quarters (assuming the expansion continues), because this is probably the #1 driver when it comes to being able to have higher inflation. The data is already starting to show the Fed is pushing on a string when it comes to increasing inflation through additional QE, so that leaves consumers having the ability to pay higher prices as the most logical outlet. Currently, U.S. consumers, particularly in the middle and lower class, are stretched and having to lever up to keep their current pace of spending. Higher wages will keep this flywheel going and potentially make it spin faster, allowing companies to successfully push higher prices on consumers without their volume becoming overly sensitive to the change.
Junk Bonds Are Sending a Negative Signal: The high-yield, or “junk,” bond market has been indicating that investors are starting to get concerned about these company’s financial prospects despite having made heavy investments in the area for the past few years. Matt Eagan, co-manager of the Loomis Sayles Bond Fund, summed up the market’s concern in a recent interview: “we think fundamentals are weakening even if the U.S. avoids a recession.” The last decade, or so, of cheap money has allowed many companies to borrow at incredibly low interest rates and, in turn, mask their weakening financial health. Investors seem to have finally had enough, rotating significant amounts of capital from high-yield bond funds into less risky investment grade bond funds starting at the beginning of August and continuing through mid-September.
Our Takeaways: In several of our previous letters, we have alluded to the structural inefficiencies that have been caused by the Fed-induced low interest rate policy since the GFC. Allowing failing companies to continue to limp along is a clear example of the distortions this type of policy creates, but it appears that investors are starting to get wise to some of the more extreme aspects of these effects. Mr. Eagan makes a good point, even if the economy doesn't go into a recession, it could still slow and that could prove to be problematic for already poorly positioned companies. Investor appetite may also play a role in the health of these investment grade companies. If the availability of capital is a significant factor in determining their viability, there's a chance that cannot be counted on. This area of the market has all of the markings of a canary, and we will continue to monitor it closely.
Check In on the Housing Bottleneck: The most recent existing home sales report shows that volume is strong for this time of year (coming in near a multi-year high) despite the market not seeing the summer spike that is typical for that season. This was likely due to supply problems as inventory (as measured in total stock and months supply) has been trending near multi-year lows all year. Analysts have been anticipating higher sales due to low mortgage rates, but as we have previously covered in our letter, significant bottlenecks exist both on the supply side and in the mortgage origination stage of the purchase process.
Our Takeaways: As we have previously discussed, there seems to be a lot of appetite for housing and loans, but a bottleneck when it comes to actual sales. A few months later we can still see this trend continuing to play out. What will be interesting over the next few months is to see if sales follow their typically seasonal trend of falling off later in the year, or if the pent-up demand ends up spreading sales out through the end of the year. It does appear that supply will definitely continue to be a drag on things since it takes a quarter or so (at the fastest) to bring new products online. Supply constraints and mortgage application bottlenecks at lenders will likely continue to suppress volume in the market until both are addressed to some degree.
Disruptions in the Repo Market: A story that is slowly still developing as of this writing is the Fed’s recent activities in the repo market. For those unfamiliar with the intricacies of inter-bank financing operations, according to the Washington Post, the repo market is: “where piles of cash and pools of securities meet, resulting in more than $3 trillion of debt being financed each day. “Repo” is short for repurchase agreements, or transactions that amount to collateralized short-term loans often made overnight. Repo deals let big investors (such as mutual funds) make money by briefly lending cash that might otherwise sit idle, and enable banks and broker-dealers to obtain needed financing by loaning out securities they hold in return. A healthy repo market is more than the world’s biggest pawn shop; it helps a wide range of other transactions go more smoothly, including trading in the over $16 trillion U.S. Treasury market.” This is of course an overly simple, but practically effective definition of this market. What cannot be understated, however, is the importance of its effectiveness and, conversely, how problematic it is when it is not working effectively. The Fed spent most of September making near daily injections of liquidity into the market which, at the very least, is a clear sign there are significant imbalances in the borrowing needs of U.S. financial institutions and the amount of liquidity currently available to meet those needs. The Fed is expected to make announcements on how they plan to address this imbalance in a more permanent manner.
Our Takeaways: The Fed kept a pretty consistent flow of funding into the repo market for most of September. While it was initially jarring, it appears they have done a pretty good job of keeping the excitement under control with additional funding. The question still remains why the additional funding is necessary in the first place. As of writing, the additional injected liquidity is well into the hundreds of billions in total which some financial reports are speculating could just become the "new normal."
A Look at the U.S. Consumer Going into Q4: There are a couple of consumer related trends we wanted to take note of as we head into the fourth quarter. The first is some Gallup polling data which shows that there has been a noticeable downward trend is consumer sentiment related to economic outlook since July. Turning to savings rates, we continue to see a gradual increase which is on trend since the GFC. U.S. consumers have tended to save more as expansions have progressed in past economic cycles. Finally, the ratio of households’ net worth to GDP has hit an all-time high with household net worth sitting at 5.3 times GDP.
Our Takeaways: The steady shifts in the negative direction for consumer sentiment data has not reached an alarming level, but the current trend is not ideal going into the holiday season. Yet, barring major shifts in the employment market, it is likely that U.S. consumers will at least keep their pocket books open through the end of the 4th quarter. With regard to savings rates, while the trend seems to be toward higher levels, we are still not talking significant percentages here. Savings bottomed out at a little over 2% in the wake of the ‘08-09 recession and have worked their way back to around 8%. Finally, looking at the net worth data, we know from other data that this is being driven largely by higher-income, higher-net worth individuals, and that this is not a "higher tide raises all boats" scenario. Risk asset price appreciation is certainly contributing to this, as are lower interest rates (interest rate driven investments like bonds and real estate see price appreciation as rates decline). It has been a perfect storm of asset appreciation since the GFC for those who have been able to own assets.
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