Businesses and consumers are likely protected against short-term recession
Recessions are sometimes hard to describe, let alone predict. Definitions vary widely. To make matters worse, some are calling their mixed forecasts a “growth recession”. Some simply describe a recession as two consecutive quarters of negative economic growth, which is clearly not true because the 2001 recession was shorter: growth in the first quarter of 2001 fell by 1.3% at an annualized rate, but between two strong quarters, both exceeded 2%.
The National Bureau of Economic Research (NBER) is the official arbiter of recessions and their definition isn’t much better. “A recession is a significant drop in economic activity that is spread across the economy and lasts for more than a few months.” The NBER specifically looks at economic indicators such as production and employment. Since definitions can be vague and ambiguous, we believe it behooves investors to focus on the overall trajectory and economic environment for businesses and households.
This time is different, or is it?
As we pointed out above, every recession has different causes and impacts, but one thing that is not different is the analysis required. Regardless of the circumstance, investors should look at several signals, not just the infamous and often misused inverted yield curve indicator. Our base case is that the national economy will weather this current storm of high prices, geopolitical risks and obstructed supply chains. Serious risks remain, but we believe business and consumer metrics support our basic thesis that the US will not fall into recession this year.
Consumers are much less in debt this time around
After the Great Financial Crisis, consumers began to deleverage. The debt service ratio and the broader financial obligation ratio gradually declined and remained stable until the emergence of Covid-19. Government pandemic relief programs, including stimulus and forbearance periods, have added volatility to consumers’ financial obligations, but if consumers are able to maintain relatively low debt levels, we believe that the consumer can successfully weather a period of rising borrowing costs without stifling spending.
Verifiable deposits are at historic levels
High savings will help consumers get through the current inflationary period. Given the uncertainty of the pandemic and the generous stimulus measures, deposits reached around $3 trillion above normal levels. During the crisis, when the Federal Reserve (Fed) cut rates sharply and individuals were highly risk averse, the cost of holding check deposits was low, so individuals tended to increase their savings , thereby increasing bank deposits. Overall savings were also bolstered by higher-income households who normally spend a higher percentage of their discretionary income on services – like travel experiences – but have been shut down during the pandemic. The accumulated savings provide some consumers with a cushion during this period of high prices and economic uncertainty.
The labor market empowers the people
Employment rebounded from lows in April 2020, but soon after the start of 2021 the rate of job creation slowed. The tight labor market is ripe for the 1.5 million former workers to return on their own terms. Such a high inflationary environment might convince some of these “lost” workers to come back. As long as the economy approaches full employment, the Fed will focus on the price stability mandate. Our base case calls for a cooling in inflation and the labor market, which could allow the Fed to suspend rate hikes towards the end of the year, limiting the risks of excessive tightening. In many previous cycles, the Fed has been accused of over-tightening and pushing the economy into a hard landing, which is the scenario where unemployment rises and economic growth contracts.
Businesses take advantage of pricing power
Consumers are probably in a safe space for the current environment, but what about businesses? The National Federation of Independent Businesses (NFIB) reports that small businesses are adjusting to a variety of current headwinds, such as a tight job market with high quit rates and clogged supply chains that are driving up raw material costs. In March, about 50% of small businesses in the United States increased their compensation to attract and retain workers according to the NFIB. During the same month, more than 70% of companies increased their prices to cover the increase in costs. Companies able to pass on cost increases will be able to protect their profit margins as labor and material costs rise.