Some years ago, a wise person told me the true definition of an economic downturn is: “having to go without stuff your grandparents wouldn’t have dreamed of having in the first place.” I am not sure who told me this. However, it has always struck me as particularly enlightened, perceptive, sagacious, etc., because it is completely true.
Further, we all know, no matter what we do today, the sun will come up in the East in the morning and set in the West. The Earth will revolve around the sun at a speed which doesn’t quite make sense to me. Babies will be born, people will die, and our descendants will take for granted that which is science fiction today. Everything I wrote about on Good Friday and more.
Regardless, the prospects or potential of economic dislocation can be, shall we say, discomforting. So, where are we now? Are we standing at the precipice of disaster? Are we, as many of the experts suggest, on the verge of a major recession or even, gasp, depression?
Inquiring minds want to know.
A few days ago, I sent out a quick note entitled “Market Woes.” Some of you might have read it. While I was addressing the recent turmoil and angst in the financial markets, I could have written much the same about the economy. Obviously, market selloffs and economic downturns seem to go arm in arm, hand in hand, and check by jowl. Want another tired cliché? Okay, where there is smoke there is fire. If so, this red ink in the markets must be signaling a come apart, right.
This is the point in the program when people who do what I do for a living make predictions which please absolutely no one but themselves. We tend to be necessarily vague or frustratingly obtuse when all people want is a straight answer. Am I right? Raise your hand if you are nodding in agreement. Uh uh…got you. Let’s try this again. Okay, Simon says raise your hand if you are nodding in agreement.
Let me cut to the quick. We are going to have a recession. There it is; I have said it. The thing is, I just don’t know the exact timing of it. It could be next year or it could be the year after that. Shoot, we might be in one right now. After all, this week, the Bureau of Economic Analysis (BEA) announced US Gross Domestic Product (GDP) shrank 1.4% during the 1st Quarter of 2022.
What is that if not a recession? Huh?
Well, there is more than a little truth to that, because recessions can take many forms. They can be severe like the Financial Crisis of 2008. Or they can be pretty mild, like the one from March 2001-November 2001 when GDP shrank 0.3%, or maybe even the one prior to that in 1990-1991 which saw GDP fall 1.4%. Then there is the recession of 1969-1970, a 0.6% contraction, which Wikipedia describes (in part) as:
“The relatively mild 1969 recession followed a lengthy expansion. At the end of the expansion, inflation was rising, possibly a result of increased deficits. This relatively mild recession coincided with an attempt to start closing the budget deficits of the Vietnam War (fiscal tightening) and the Federal Reserve raising interest rates (monetary tightening).”
My point is there are recessions and there are RECESSIONS. The most recent one in 2008-2009 was a RECESSION, and folks are scared of another doozy like that one. Fortunately, as I type here on April 29, 2022, that doesn’t appear likely. In fact, I would say it is pretty remote, as that last one was the result of a near financial system collapse. In truth, most people can’t appreciate just how close it actually was to one. Nor do I think it will approximate the recession of the early 1980s which Paul Volcker arguably engineered to throttle severe domestic inflation.
Why not? The answer is basic economics.
In order to mitigate the worst of the economic downturn(s) due to the pandemic, the various powers that be flooded the US economy and financial markets with cash. I won’t bore you with all of the particulars and rationales other than to say M2 (the most widely used proxy for the US money supply) grew at a 12.3% rate in 2021 and at an eye-watering 24.8% clip in 2020.
As we all well know, that unprecedented growth fueled an even more unprecedented increase in consumer demand. This led to well-documented problems with supply and distribution. If you remember all the way back to your Econ 101 class, you might remember this: prices go up when demand is greater than supply.
So, what has happened since then?
As the various stimulus packages and financial lifelines have expired, so has the surge in M2. In fact, over the last 12 months, the rate of growth in the US money supply has fallen rather sharply, believe it or not. In March 2021, the annualized 3-month growth rate in M2 was 16.4%. The increase over the previous 12-months had been 24.2%. Let’s just say those numbers are significantly higher than average, much more so.
Conversely, through the end of March 2022, the YTD annualized growth rate in M2 was a very normal 6.2%, and has been trending downwards for the last 10 months. Further, the 12-month growth rate in the money supply has fallen to 9.8%, and will continue to fall as 2021’s gaudy monthly growth rates fall out of the equation. In short, the growth in the money supply is getting back to normal.
If this is in fact the case, and it is, consumer demand should also be getting back to a more normal level, which it has. According to the BEA, US personal consumption expenditures grew 2.7%, annualized, last quarter. They were 2.5% during the 4th Quarter of 2021, and 2.0% in the 3rd Quarter of last year. By historical comparison, these are very average observations. Conversely, the previous 4 quarters, 2Q 2021 through 3Q 2020 were, respectively: 12.0%, 11.4%, 3.4%, and 41.4%.
To put that last line into perspective, going all the way back to 2Q 1947, consumer demand in the US for the 2nd Quarter of 2021 was the 4th strongest on record. It was the 6th strongest during 1Q 2021, and the 3rd Quarter of 2020 was the strongest quarter for the US consumer ever…by far. Not even close.
In a nutshell, here is what happened: economic restrictions, lockdowns, and fears about contracting COVID-19 destroyed consumer demand during the first two quarters of 2020. The reopening of the economy coupled with an unprecedented amount of money to goose demand created a proverbial pendulum effect. This, as we now know, caused demand to grow at a much more rapid rate than supply, and prices have soared as a result.
Demand, while still growing, is currently cooling substantially. This is allowing supply to catch up for the first time in quarters, as is evidenced by the sharp increase in the monthly inventory numbers. To that end, wholesale inventories surged 2.3% during March 2022 and retail inventories climbed 2.0%. In fact, and this actually might be a little scary going the other way, wholesale inventories have grown at a 21.2% rate over the last 12-months, according to the US Census Bureau.
Put another way, inventories (supply) are exploding while M2 and consumer demand are increasing at a substantially slower rate. In essence, the growth in supply, as I type, is far exceeding the growth in demand. Again, going back to your Econ 101 class, what should soon be happening to many types of consumer products?
If history serves as a guide, and our compliance people would like for me to say it doesn’t necessarily, you guessed it: prices should start to fall on their own without assistance from the Federal Reserve. IF so, this means the Fed won’t have to be as aggressive as people currently fear in crushing inflation, like Paul Volcker did. This means it is still quite possible for the Fed to supposedly ‘engineer’ a soft landing for the economy, as opposed to driving it into the dirt.
Remember, a slowing consumer is NOT a contracting consumer. As such, the tea leaves are currently suggesting any upcoming recession, and we could actually be in one right now, will be more of an inventory correction than an economic collapse. If so, again with the if so, this means it should be more shallow, and brief, than the folks on the television are currently suggesting.
The question then is: when will everyone else come to the same conclusion and quite stressing us out?
Over the next several months, the 12-month, so-called “core CPI” should start trending downward. That’s right. This index excludes food & energy, which everyone obviously needs to survive. However, the core CPI supposedly does a good job tracking whether inflation is long-term systemic or due to short-term pressures, like vagaries in the commodities’ markets.
The reason why I/we believe the core rate will start to slow is the monthly data is already doing so. Next month, meaning April, the 12-month CPI equation will remove April 2021’s 40-year monthly high of 0.9%. In May and June, we get to omit last year’s 0.7% and 0.8% numbers respectively.
IF we replace them with a 0.4% number, which seems reasonable to me as I type (if not slightly high), the 12-month core CPI will fall from 6.5% today to 5.2%. If we get a repeat of last month’s 0.3% reading, the number drops down to 4.9%. While that is still higher than anyone would like, it IS moving in the right direction without any help from the Fed, which means, again, the Fed won’t have to be quite as aggressive as feared.
Whew.
Clearly, I have gone on longer than normal today, and I appreciate you reading this far. As I started, recessions are little more than “having to do without stuff your grandparents wouldn’t have dreamed of having in the first place.” This has been true of all recessions in the past, and will undoubtedly be true of all of them in the future. The next one shouldn’t be an exception. However, if we are right, it won’t have to be for very long, and you might not even feel it.
In the end, if you take nothing else out of this week’s missive, just know, at Oakworth, we are hard at work peeling back the layers of economic onions, looking into our crystal balls, pouring over data sets, analyzing situations to the point of overkill, playing ‘devil’s advocate,’ and searching for logical solutions and outcomes for what appear to be illogical situations. This analysis is a reflection of the hard work our Investment Committee always does, and I hope you enjoyed it.
Chief Economist
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows not only on this day but on every day, and may the conflict and bloodshed in Ukraine end quickly.
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.