Wall Street’s fearmongers were totally wrong about a recession
Wall Street analysts and economists have always had a tendency to fall in love with their forecasts. They don’t like to admit when they’re wrong, and even as the evidence against them piles up, many stick to their guns. This stubbornness helps explain why Wall Street is having an exceptionally hard time letting go of the idea that a recession is just around the corner.
As the forecasts for recession keep failing to come true, the explanations for this delay are always explained away. Strong jobs growth? It’s a late-cycle sign that the end is nigh. Rally in US equity markets? We had a big rally in mid-2008, too. Housing picking up? It’s only because inventory is low.
Despite the year-plus in which analysts have been arguing that a recession is imminent, none of the arguments behind the predictions stand up to scrutiny. And there’s only so long one can keep claiming that the recession is just six months away. Given the increasing number of reasons to be upbeat on the US economy, it’s time for the recessionistas to admit defeat. The economic doomsday clock has been reset.
Bear growls
Over the past year, Wall Street pessimists’ reasons for an approaching recession have shifted. First, it was the spike in food and energy prices, then it was the housing market, and now it’s “long and variable lags” from rate hikes that many of the same people said the economy couldn’t handle in the first place. Despite the moving goalposts, it’s important to get a sense of the bears’ current arguments to better understand why the calls for economic doom are overblown.
One of the popular indicators for recessionistas is the slowdown in bank lending. The data shows that banks are increasing their standards of who qualifies for a loan, meaning fewer people and businesses are getting access to credit. As this spigot of money gets cut off, the argument goes, retail spending and business investment will drop off — cutting off the main driver of economic growth. I think there are a couple of issues with this line of thinking.
First, bank lending is a lagging indicator: The growth rate of money loaned out tends to peak when the country is already in a recession and bottom out after a recovery has already started. For all we know, the slowing in bank lending is a response to the slowdown in growth last year and tells us nothing about the future. Second, lending standards on loans for small, medium, and large businesses have been tightening for the past four quarters. But that doesn’t seem to have put a dent in the economy, which has generally performed ahead of expectations during the same period.
This disconnect between lending and the actual performance of the economy could be because the post-pandemic cycle is being driven by higher incomes instead of increasing credit balances. Americans received sizable pay raises and plenty of pandemic stimulus that they could lean on — not needing to charge everything to the credit card. As evidence, bank loans as a percentage of GDP is roughly equal to where it was in 2016, meaning increased debt has not been the driver of activity for roughly seven years.
What about the claims that America’s job market is spiraling downhill? Growth pessimists have recently begun pointing to the increase in the number of people claiming unemployment insuranceas a sign that the long-resilient labor market is turning for the worse. Typically, they say, whenever claims rise this much from their 12-month lows, a recession follows.
Again, there are issues with this approach. For one, the initial claims data has not been especially clean — there have been noted data issues, and sharp increases one week get revised away the next. But even if we take the data at face value, it’s worth noting that there’s a disconnect between initial jobless claims — people who are filing to receive benefits — and continuing claims, which measure who’s actually getting them. Continuing claims have not risen nearly as much as one would expect given the rise in initial claims, which indicates people are finding new jobs relatively quickly. And other labor-market data remains strong. Layoff announcements have slowed considerably, especially in the tech industry, and the total layoff rate remains low. Finally, despite the recent uptick in initial claims, the monthly jobs reports have remained surprisingly strong.
Bears are on a bit firmer ground when discussing the weakness in the commercial real estate sector, but even there, I’m skeptical the issue is nearly as bad as is being portrayed. Structures investment — which includes spending on nonresidential buildings such as strip malls, offices, lodging, and power plants — is less than 3% of the US GDP and only a part of that is the problem. Office real estate gets most of the attention given the stickiness of remote work and the lack of occupancy in downtown urban centers, but office construction is actually a small share of commercial real estate these days. Power and manufacturing make up a bigger chunk of the sector’s investment, and these areas are seeing private investment crowd in because of federal fiscal policies such as the CHIPS Act.
While the case for a sudden slowdown in the economy is complicated and full of holes, the argument for a strong rest of 2023 is pretty straightforward.
Blue skies
As the labor market holds strong, consumer-price inflation is cooling rapidly. Food and energy bills are sliding, used-car prices are likely to drop this summer, and the once soaring cost of rent is coming off the boil. This represents a tailwind for household incomes and consumer spending.
The drag from the US housing market is fading. The housing sector sliced off nearly a full percentage point from the GDP over the past year, but there are clear signs the once battered industry is staging a bounce back. New-home sales have hit one-year highs. Surveys of homebuilders show that they are upbeat despite an increase in mortgage rates — which is notable since changes in builder sentiment tend to presage the direction of real-estate investment over the following few quarters.
Similarly, inventories that have been cutting GDP growth over the past year will likely turn around. Businesses built up a stockpile of goods during the worst of the supply-chain crisis in 2021 and 2022 and have been slowly selling off that glut over the past year. Without the need to order new goods, this inventory buildup contributed to the slowdown late last year. If consumer spending holds up, as it looks like it will, firms will need to restock inventories, which will, in turn, support US factory production and investment up the supply chain.
Another check in the “continued growth” side of the ledger is the improving outlook for financial markets. This time last year, stocks were in steep decline, corporate-debt markets were showing signs of stress, and the dollar was climbing, which made it harder for American companies to export their goods. In short, markets were anticipating recession, creating a negative feedback loop for the economy. This year, market developments have moved in the opposite direction. Importantly, the Federal Reserve has started to slow its aggressive interest-rate-hiking plan and has signaled that it doesn’t expect the economy to buckle in order to achieve its inflation-fighting goals.
These positive factors don’t exactly scream “recession.” A popular quip last year was that “housing is the business cycle” or that “housing is the quintessential leading indicator.” Well, housing is clearly accelerating. That is no longer a disputable point. Growth pessimists tend to put quite a bit of currency behind the idea that the Federal Reserve’s interest-rate hikes will have “long and variable lags,” meaning the tightening will take awhile to kick in before it sends us off the cliff. But the Fed has already been tightening for 18 months, and it’s the interest-rate-sensitive areas of the economy that have shown improvement of late — if anything, the economy has already digested the hikes and moved on.
Heads, I win. Tails, you lose
Growth pessimists seem to lack logical consistency in their views. Their arguments are constantly contradicting: “Growth is holding up, which means the Fed must hike interest rates even more, which is bad for stocks.” “Actually, growth is weak, and the Fed has already hiked interest rates too much, which is bad for the economy and stocks.” Another concern about the market is that the stock-market rally is the result of only a few companies, which is a bad sign. But in 2022, the stock market was selling off while breadth — a measure of companies whose stocks are moving higher — was better, but this was also bad. Most recently, economic doomsayers argued that defaulting on the debt would be bad, but once the debt limit was resolved and the Treasury General Account was refilled, it was also bad because that meant the issuance of new Treasury debt would attract investors away from stocks.
It’s starting to make my head hurt! At some point, rational people have to put their hands up and say, “You are wrong.”
There is opportunity in this intransigence, however. If the consensus continues to have a tough time letting go of the recession forecast, that means stocks have room to grind higher as forecasts continue getting revised up and investors slowly come around to the potential of the economy’s continued improvement.
But by the time analysts start to come around, the damage will have been done. The recession calls have put the idea of a slowdown at the top of investors’ minds for over a year, and people who sold or got defensive with their portfolios will have missed out on strong market gains this year. The economists and forecasters who banged the doom drum may take a reputational hit, but that’s nothing compared to the financial confusion they’ve caused for average investors.
My broader point is simple. The near-term recession risks are fading rapidly. There will be no recession in the next six months, and it’s increasingly likely that we won’t see one in the next year, either.
Neil Dutta is head of economics at Renaissance Macro Research.
Read the original article on Business Insider
Source: https://finance.yahoo.com/news/time-wall-streets-fearmongers-admit-172900110.html