Some things really aren't that different.
PUBLISHED OCTOBER, 2023
“The four most expensive words in the English language are, ‘This time it’s different.’” — John Templeton
Famous last words, or as most in investment management and economic forecasting realize, words that shouldn’t be used during serious conversations. As soon as we believe that “this time it’s different,” we eventually find that no, it isn’t different.
History seldom repeats itself, but it typically rhymes. The late Sir John Templeton, a natural optimist with a strong contrarian streak and one of the greatest investors of all time, suggested that these are “expensive” words for an investor to use.
Some are suggesting we are far from an economic recession and that this time, the cycle is different and that the Federal Reserve has figured out how to manage a sustained soft landing. But according to my friend and former professional colleague, Robert Dieli (the author/owner of the NoSpin FORECAST), the Fed has failed at all attempts at a soft landing since 1966-1967. While I recently lowered the probability of an economic contraction occurring this year, I suggested the probability of the economy slipping into a light recession remains on the table for the next year or so. I stand by that view.
So far, the expected recession is tardy. What gives? Our indicators (yield-curve structure and Leading Economic Index rate of change) have historically and reliably given us warnings of economic weakness with a time lag that has been long and variable. For example, the time between a sustained yield-curve inversion and a resulting recession has averaged 14 months over the past seven cycles. We entered a sustained-inversion condition last summer. Those suggesting that this time it’s different should keep this in mind.
From a fundamental standpoint, why haven’t we entered a recession? Several factors are in play:
• Consumer trends. Household savings balances ballooned to very high levels during the pandemic, thanks to government largesse. Another piece of the extended consumption pattern is explained using revolving credit by consumers, which leads to credit card debt; revolving credit is now hitting the highest levels in history. A final point: Many consumers have locked in very low mortgage-interest rates (by some estimates, 80 percent of outstanding mortgages bear rates of no more than 5 percent). Thus, many consumers have more discretionary spending power than would otherwise be the case.
• What of interest rates? Stephen Dover, head of the Franklin Templeton Institute, said in Barron’s that businesses, along with consumers, have also been taking advantage of low rates. Since 2007, U.S. investment-grade and U.S. high-yield debt markets mushroomed from $2.1 trillion to $7.8 trillion, and from $700 billion to $1.2 trillion. At the same time, global private credit grew by $1 trillion.
• Business resilience. The corporate sector seems more resilient to Fed rate-tightening effects than seen in previous cycles, partially due to debt maturity extensions and moving debt away from the commercial banking system, effectively blunting some of the impact of Fed policies. But over the long term, new borrowings will be required, either because of business growth or for refinancing of existing debt. While different, business’s debt restructuring hasn’t eliminated the business cycle, only delayed the probable impacts.
• Washington’s role. Federal debt now exceeds both household and business debt by a wide margin. As half of that debt matures over the next six years, we could see financial stresses negatively impact the exchange rate of the dollar, along with whatever interest rates the world’s investors may demand for further debt issuance. Reflecting the increased leverage and the dysfunction present in Washington, two of three rating agencies have cut the government’s credit rating.
The best news is the fact that the entire U.S. economy (business, consumer and government, combined) isn’t much more levered than it has been historically in relation to overall GDP. We certainly can’t thank the government for that: Federal government debt levels have grown dramatically over the past 15 years, regardless of who was in office.
While I don’t think we will see a recession start this year, that doesn’t mean one may not be forthcoming in 2024. However, the data point to the recession being softer and not as vicious as in the 2008-2010 downturn, as it highlights the view that the nation’s income statement has bought time at the expense of the country’s overall balance sheet.
Therein lies an apparent real risk for the economy going forward—a government that has strengthened national GDP by the issuance of more than $8 trillion in new debt since the beginning of the pandemic year of 2020. Will the government slow its debt-issuance level? With next year being an election year, politicians of all stripes know their chances of reelection are hurt if the economy falls into an economic funk prior to Election Day.
The first rule of “hole management” is to stop digging if you want to get out of one. I don’t believe the government will stop digging before the 2024 election. While it is too early to make a formal call for 2024, the year may prove interesting.
This commentary is provided for informational purposes only. Opinions are subject to change; for more information, visit www.marinerwealthadvisors.com.