The question on many minds and certainly the topic of much financial media coverage lately is whether or not the U.S. economy is headed for recession. Real gross domestic product (GDP) decreased at an annual rate of -0.6% in the second quarter of 2022, following a decrease of -1.6% in the first quarter.
The first look at Q3 GDP was released on October 27th, and according to the Bureau of Economic Analysis, the advance estimate was +2.6%.
Commentary from the BEA website stated, “The upturn primarily reflected a smaller decrease in private inventory investment, an acceleration in nonresidential fixed investment, and an upturn in federal government spending that were partly offset by a larger decrease in residential fixed investment and a deceleration in consumer spending. Imports turned down”.
There has been much debate about the previously recorded back-to-back negative GDP prints for Q1 and Q2 signaling a “technical recession”. It is, however, The National Bureau of Economic Research (NBER) that has the responsibility of determining when a recession begins and ends.
More specifically, it is the Business Cycle Dating Committee within the NBER that decides. According to their definition, “A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators”.
The problem with the official designation is the 12-month average lag time between an inflection point, whether entering or exiting recession, and the Business Cycle Dating Committee announcement confirming such an inflection point.
For example, the committee’s economists waited until December 2008 to declare that a recession had begun in late 2007. In the interim, Lehman Brothers had already gone bankrupt, and the financial crisis was wreaking havoc on the U.S. economy and financial markets.
Sticking with facts versus media narratives, an increasing number of indicators of recession are manifesting themselves in the economic data.
Even if we don’t officially find out for months to come, the U.S. economy is already in, or on the precipice of recession. While there are many deteriorating data points, let’s focus just on the U.S. Consumer since the BEA noted a deceleration in consumer spending in their recent release (underlined in above).
Approximately 70% of GDP comes from consumer spending. As such, the U.S. economy is characterized as a consumption economy. When consumption slows, GDP suffers. There are some disturbing datapoints that show tangible issues developing as it pertains to the financial health and spending capacity of the consumer.
For starters, August marked the 17th consecutive month of negative wage growth. In other words, while wages are increasing, inflation is rising much faster and continues to strip away more and more purchasing power. As such, it may be possible that the following data points are biproducts of negative wage growth and the consumer that may be in a substantially weakened financial position.
First, the Federal Deposit Insurance Corporation (FDIC) reported a record drop in bank deposit accounts of nearly $370 billion in Q2. Household savings is now well below pre-pandemic levels. The bottom quintile of income earners has been impacted most severely, spending down nearly $44Bil in savings in Q2 and over $60Bil YTD.
Next, the Personal Savings Rate data shows retracement to a 13-year low (2009). Putting these two points together, it tells a story that not only has the consumer spent the money from their bank accounts, but they are also saving less.
Third, new data from the NY Federal Reserve Bank in Q3 revealed that in the second quarter of this year, 233 million new consumer credit accounts were opened. The total amount of revolving credit card debt also continues to climb on a national level.
Lastly, in recent months the major credit card companies are reporting an uptick in credit card payment delinquency rates. Delinquency trends continue to climb in auto loans, too.
These are not bullish signs, but rather one of many that portend a rapidly weakening consumer economy.
The strength of corporate earnings also shows signs of decay. Earnings season is roughly halfway complete. Top lines sales growth on the aggregate for S&P 500 companies continues to show modest year-over-year growth, but bottom-line earnings (earnings per share or EPS) is trending negative.
The outlook is unfavorable for earnings growth, and we believe forward-looking guidance and earnings expectations are too high.
Total money supply falling due to Federal Reserve rate hikes and quantitative tightening creates less economic liquidity and higher interest rates.
As a result, corporations have a higher cost of capital because accessing credit is more expensive.
Households have less purchasing power which impacts sales and adversely impacts economic demand.
Corporate investment is slowing. A stronger U.S. dollar is creating currency headwinds for large multinational corporations.
Lastly, corporations are coming off of peak profit margins.
Combining these headwinds in a recessionary macroeconomic environment makes an earnings recession seemingly unavoidable.
The secondary effect of an earnings recession is severe balance sheet impairment for the weaker, more leveraged companies. This brings about problems in the credit market, particularly in high yield bonds.
Signs of trouble are showing here, too, as the prices of high yield bonds are falling – reflecting the concern of default risk.
The cost of insurance on bond defaults, called credit default swaps (CDS), is also rising.
If the Fed stays the course, and if this recession drags out a few quarters, it should not surprise anyone to see a wave of bankruptcies in corporate America, and unfortunately, some small businesses may suffer the same fate.
- Hedgeye Risk Management
- Bureau of Economic Analysis
- U.S. Bureau of Labor and Statistics
- CME Group