100% Used to be Pretty Good Odds

It was just over a year ago that Bloomberg ran the now infamous headline: “Forecast for US Recession Within One Year Hits 100%”. Obviously that call was a bit off considering the strong 3q GDP growth data recently released. ?In fairness to all those doubtless economists, they were all looking at a long list of indicators that said the same thing, which is that a recession is right around the corner. Never before had we seen such deep Treasury curve inversions without a recession. Never before had we seen the tightening in credit conditions as measured by the Fed’s Senior Loan Officer Opinion Surveys without a recession. Never before had the Leading Economic Indicator’s plumbed such depths without a recession.

Now we are getting a new batch of never (or rarely) before indicators coming from the resilient labor market. Both measures of hours worked, and overtime hours have fallen in a manner that is consistent with a recession. Temp jobs have been very weak for some time, which has historically been a very good indicator of a pending contraction. Since Friday’s slightly softer than expected Non-Farm Payroll report, the focus is on the move in the unemployment rate, which has now moved up from 3.4% to 3.9%. Economists are looking at “The Sahm Rule” which states that whenever the three-month moving average of unemployment has risen by half a percent, a recession is right around the bend. We aren’t quite there yet but the trend of the broad swath of employment data is clearly weakening.?For the Sahm Rule to be triggered only requires the unemployment rate to go sideways next month.

So where does that leave us? Our view is that the economy is slowing, and we may see some acceleration to the downside as a result of the housing market finally beginning to weaken and small businesses finally starting to feel the pinch of higher interest rates. Construction jobs have yet to fall, but new-home (especially multi-family) inventories are starting to rise, and we have a considerable amount of in-process construction that will soon be completed. As absorption rates fall, we will start to see job losses in the construction sector. Beyond just housing, we have seen the ABI (Architectural Billings Index) soften meaningfully, which is viewed as an important leading measure of commercial construction.

Ultimately, our view is that, given all the factors enumerated above, we will likely see some level of a recession. The more important question is: what is the catalyst to reaccelerate? We think we are in for an L-shaped recovery. We see a long-term scenario with lower potential GDP and higher inflation volatility that prevents the Fed from resuming Quantitative Easing and Congress is out of room to expand stimulus anytime soon. We also see a recession that will look very different than precedents because of the secularly tight labor supply. Without question, many industries, especially construction, have lots of jobs to shed but the new normal is likely to have employment rates remaining much lower than in the recession spikes of the past. That’s a good thing.

Andrew Keizer Anthony Lewis Katie (Munn) Gaunt Charlie Yoachum Alex Samoila Drew Dokken Wade Dokken Lincoln Collins Matt Hamann Grant Collins, CFA Jackson Bolstad Brooks Boucher M.J. Schiff, CLTC? Emma Bonthius Tim Pierotti

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