It Ain't Over Till It's Over!

Thanks, Yogi.

There were a few weekend readings that I feel need to be addressed. The first is How Experts Got It Wrong On Economy on page B1 of the Saturday NYT and The Fed Confronts an Urgent Question: Can Investors Have It All on page 6 of Barron’s (Randy Forsyth’s Up & Down Wall Street column).

Let’s start with the NYT article. The opening line says it all: “The recession America was expecting never showed up.” Showed up “yet,” you mean.

Indeed, this same time last year, the Bank of America global fund manager survey showed that 68% of portfolio managers were positioned for a recession; today, that number has been pared to 17%. That said, corporate earnings did stagnate in 2023 but the stock market still managed to advance +24% (!), on the back of a bubbly expansion in the P/E multiple. The recently released NABE survey shows that a mere 9% share of business economists believe the economy will slip into recession this year.

Let’s look at 2023 and take a holistic view of the economic backdrop. First, real GDP did close the year strong at a +3.3% annual rate in Q4, which was +1.6% after the unusually warm weather is adjusted for (a 2.5 standard deviation event). Looking at the sequential pattern of GDP through Q4 (seeing as we already have October and November in hand), to believe in the fourth-quarter figure, you would have to ipso facto believe that December rang in with a +26% annualized surge in real GDP. Then again, it was the balmiest December in recorded history, back to 1921 (40 degrees versus the norm of 33 degrees). The government statisticians are using December seasonal factors to massage the data and render them comparable sequentially when it felt more like March outside (warm weather and spending growth go together).

Not everything has come up smelling like roses. In the final six months of 2023, the Household Survey showed no employment growth at all. It was actually worse than that because 1.6 million full-time jobs were shed and replaced by 1.6 million part-timers. This development was underscored in the coveted Payroll survey, as we closed the year with the average workweek depleted to 34.3 hours. Companies have been hoarding labor but are furloughing full-time jobs (for part-time) and cutting staff hours. At 34.3 hours (where it was in April 2020), we have reached a point where businesses are now going to have to make some tough decisions. The moment the Payroll Survey begins to mimic the information embedded in the Household Survey, watch out!

Few people know that there are two official surveys of employment. The majority cling to the Payroll Survey, just as they do with the holy grail of GDP — not realizing that real GDI was flat in 2023. The gap between GDP, which is spending, and GDI, which is income, has never been so wide. We are in a real income growth downturn, at the same time we experienced a real spending growth uptrend in 2023.

But seeing as everyone salivates over GDP as they do with nonfarm payrolls, it is time to address where I went wrong last year.

First, I never thought we would close the year with a depleted 4% personal savings rate — half the pre-COVID-19 norm and a level (or below) we have only seen 8% of the time in the past. The historical record and all the academic research showed that when confronted with a cash transfer from Uncle Sam, half of the windfall gets spent and half gets saved. Not much different with how rational people treat a winning lottery ticket. But today’s group of narcissistic YOLO consumers spent all the cash stimulus. All $2 trillion in less than three years’ time. Incredible. But this is what happened.

Now, as the low-end and middle-income households worked through their excess pandemic savings ahead of the upper-end echelons (who instead were busy investing and trading their accounts with the proceeds), they then began to tap into their plastic like it was nobody’s business. I never expected outstanding credit card balances to mushroom nearly 10% last year — a year in which consumer credit card delinquency rates hooked up sharply to 2012 levels (when the unemployment rate was 8%, not 3.7%). I mean — just go back and read Thursday’s WSJ page B1 story titled Credit-Card Spending, Delinquencies Rise. To wit: “From fuel and groceries to hotels and airline tickets, consumers are putting more purchases on credit cards — and taking longer to pay them off.”

There’s your macro theme as far as 2023 was concerned — a year replete with anomalies, inconsistencies and, much like the equity market, notable divergences. A recession averted as Main Street took a feather out of Wall Street’s cap — leverage!

Now, as for that Barron’s column, what is making the rounds is the citation from research published by Joe Carson showing that there has never been a recession in a year when nominal GDP growth was at a premium to the Fed funds rate. The argument is that the inverted yield curve is simply no match for this time-worn nominal growth-funds rate differential. Fair enough. But a few counterpoints are required, nonetheless. The nominal GDP growth minus the Fed funds rate is a coincident indicator. The yield curve is a leading indicator and quite often leads by 18-24 months. So, the curve inversion, having first inverted in the fall of 2022, was always providing the recession signal for 2024, not 2023.

Nominal GDP growth of 6.3% in 2023 surely did top the 5% funds rate. But at this point, who cares about 2023 any longer? Which is why I was shrugging my shoulders at the article. The question is what is in store for the coming year — the Fed’s nominal GDP growth forecast is 3.8% for 2024 and the Fed funds rate, as per the dot plots, will average close to 5%. So, I intend to write about this gap for the 2024 outlook and leave it to Joe and Randy to dwell on what happened last year.

You can’t make this stuff up — the more delayed the payments became, the more debt the credit finance companies allowed households to tap. I had expected that the survey data showing the banks to have sharply tightened the screws on credit card lending guidelines would have precipitated a contraction in loan availability. Far from it. There seems to be this need, this desire, to have the most financially stretched segment of the consumer space keep the ball rolling at all costs. I mean, there is no textbook that would tell you that rising credit card delinquencies would lead to ever-greater credit card extensions. And this helps explain the gap between spending and income — the former having been juiced up by a further savings drawdown and ongoing leverage.

So, this is where I went wrong with my assumptions in 2023. But on the expenditure side. The income side of the ledger did broadly come in line with my expectations. But everybody knows that measuring economic success via organic income is for losers. Success by today’s standards is measured by leverage, not income. That is how private debt and equity operators have proliferated and flourished these past number of years. Go and ask how much of their excess returns were juiced up by leverage as opposed to actual investment acumen. You’ll be in for a shock.

The same is true for GDP — last year was about stimulating spending with extra leverage. And here I thought that what we would start to see (surveys were on board but were obviously a “head fake”) was a deleveraging cycle to commence. Silly me. Not even a 500 basis point interest rate shock could manage to derail a consumer addicted to debt, which is now being compounded by the growing use of “buy now, pay later” retail sector strategies. But does the “pay later” part of this craze ever happen? Or is this no different than the Federal government’s never-ending policy of kicking the fiscal can down the road, up until the debt blows up the financial markets?

Speaking of the government sector, I also misjudged how intensive a role it would play in 2023. Fiscal stimulus accounted for two-thirds of last year’s GDP expansion. Incredibly, the deficit ramped up by $365 billion to $1.8 trillion. That boggles the mind. I remember the years, not that long ago, when $365 billion was the deficit. Now it’s a number that symbolizes the annual change in the deficit. A ballooning deficit like this in the context of 6% nominal GDP growth is unprecedented outside of recessions. It’s not just government spending but the massive breaks, subsidies, and sweeteners to the business sector under the Inflation Reduction Act and the Chips Act — incentives to “green” the energy grid and make America a world giant in the realm of semiconductor production.

So, get this: in a year that saw nominal GDP growth come in just slightly north of 6%, government revenues fell 7.2% or by $350 billion. This was a first. Consider that with the multiplier impacts, historically, a 6% nominal annual GDP growth rate spins off an 8% revenue stream for Washington. Not this time and this was an unprecedented divergence and attests to the vast array of “tax expenditures” the Biden team doled out to businesses of all types but mainly towards the industrial construction sector. These subsidies were so enormous, that they touched off a 60% construction spending boom in manufacturing factories in 2023. At the same time, manufacturing production was flat in 2023. Is this a case of “build it and they will come” or is this more a case of Biden trying to buy votes into an election by building the equivalent of “Potemkin” villages?

It also begs the question — if the economy is in such fine shape, then why all the fiscal stimuli? And if the consumer financial situation is so sound, why have the retailers gone bonkers on gimmicks to stimulate sales and why it is that the homebuilders have also felt compelled to bring potential buyers in the door with aggressive promotions and price discounting?

The overriding questions for 2024 will be: how much more fiscal expansion can we stomach and what other rabbits will the consumer pull out of the hat? Most of all, how much longer can the business sector play the role of that little boy with his fingers in the dyke — what happens to the job market once the dam breaks on this “labor hoarding” file? As far as I’m concerned, this is where the rubber will meet the road in 2024, and the bull market in complacency will unravel as the recession few see, and few are positioned for, finally comes into view. The painful drawdown in 2022 should serve as a reminder for what happens when recession risks get priced into the equity market — and that year didn’t even see the real thing take hold. If that happens, think of what happened in 2022 as an appetizer. And if I recall, we went into that year filled with smug complacency and extended valuations, much like we have on our hands today.

As an aside, not everyone out there is waving the pompoms — in case you missed it, Bob Rubin penned a sobering op-ed piece in Friday’s WSJ titled The ‘Soft Landing’ Could Easily Turn Hard. Well worth a look.

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