David Shulman
Senior Economist
“The risks of a recession in 2020 may be next week,” was the opening statement by Mr. Shulman.
First Quarter GDP Growth Not as Good as it Looked
While 2019 Q1 GDP was originally reported at 3.2%, when economists considered the reductions in exports and imports resulting from ongoing trade disputes, combined with increases in State and Local spending, the actual figure is 1.2% growth for the core economy. Shulman predicts a growth of 1.6% for 2019 Q2.
The Household Survey & Payroll Employment Divergence
The Bureau of Labor Statistics has two monthly surveys that measure employment levels and trends: The Household Survey, and the Payroll Survey. Both surveys are needed for a complete picture of the labor market. The Payroll Survey counts the number of jobs, while the Household Survey counts the number of employed individuals. A person with multiple jobs will be counted several times in the payroll survey but only once in the household survey.
Year after year the Household Survey has increased by 2.6 million jobs whereas the Payroll Survey increased by 1.4 million jobs. This divergence might be a sign that employment growth has been less than the headline figures from the Payroll Survey suggest. We’ll see in coming months whether this pattern continues, or whether one series starts tracking the other more closely.
GDP
Shulman predicts GDP growth of 1.6% for Q2, and 1.8% for Q3. He does not believe GDP will exceed 2% in 2019. Shulman further predicts anemic GDP growth of 1% in 2020, a rate that creates significant risk of the US tipping into a recession.
The 10-year treasury note rate (at the time of the Forecast) was 2.1%, while a 2-year note pays 1.8%. Equity markets have priced in two rate cuts for 2019. Shulman sought to revise one of his comments from the March 2019 Forecast when he wrongly predicted that the Fed would hold off on lowering rates. Since the Forecast the yield curve is now inverted, the 10-year is 1.59%, while the 2-year is 1.53%.
Unemployment
Unemployment is currently at 3.7%, where Shulman predicts it will remain throughout 2019. He expects it to increase in 2020, leveling off near 4%. Shulman noted, however, that if the economy does sink into recession, that rate could increase to the 5 - 5.5% range. Unemployment compensation benefits have been running near 3%. Shulman expects wage growth of 4% for calendar year 2019, with labor markets still very tight.
Trade Wars
Proposed punitive tariffs against Mexico could have a much greater impact on the US economy than those against China. Supply chains between Mexico, Canada, and the US, are the tightest in the world. Car parts used in the manufacturing of automobiles in Mexico, Canada, and the US, travel back and forth between the three nations 4-5 times, and would be subject to tariffs each time, possibly resulting in an over-20% increase in pricing. Tariffs could create the risk of an auto industry slowdown, which could result in potential layoffs. The fear of tariffs and antitrust issues affect multinational companies, making it difficult or near-impossible to predict their effects, thereby creating uncertainty, which results in reduced capital investments.
Ed Leamer
Senior Economist
The economy has 3 phases: healthy, recession, and recovery. An essential feature of the UCLA Forecast is to try and predict the transition from a normal economy to a recession. Investors need to worry about the next recession as it will result in weak revenue flows, weak cash-flows, and declining asset values. The right financial advice is to borrow heavily during the expansion phase, easing up as an expansion continues, and backing off debt as time goes on to build up cash reserves. In a recession, cash is king. Leamer suggests preparing by taking on low leverage debt today, along with a conservative approach to underwriting, as the risk of a recession is elevating.
What’s the risk of a recession?
The current expansion phase has been going on for 120 months, as of June 2019. Unlike previous expansions, however, this one’s seen slow growth, with an accumulated GDP growth of only 20% since 2009.
The components of the GDP tell the story. Traditionally, the main contributors to GDP are durables, non-durables, structures, equipment and government. As the US has shifted from an industrial to post-industrial nation over the past decade, the contributors have also changed with intellectual property now the primary driving force behind the economy.
Leamer predicts a higher likelihood of a 2020 recession, driven by the inverted yield curve. His perspective is that bank operations fundamentally change as the yield curve flattens and inverts. Banks focus more on risk mitigation and begin to tighten lending standards. Is the US economy in a fragile state like it was in 2006 and 2007, based on a housing bubble? Leamer says no, the US is not in a fragile state. While the historical data serves as an alarm, Leamer believes a recession is not likely to occur in 2019, though one may begin in 2020.
With recent rate cuts and continued perceived strength in the overall economy, capital is still readily available, and most banks are eager to lend. However, we’ve noticed some lenders, such as Chase, have begun to tighten their lending standards and carefully scrutinize buyers who have little or no apartment management experience.
Is this a telltale sign that Chase predicts something is coming around the corner and only wants experienced operators worthy of weathering a storm? While Chase hasn’t stopped lending to less-experienced borrowers, they have reduced loan-to-value ratios from as high as 70% to the 50% range, and at higher interest rates.
