Monday, October 14, 2019

Signs of Recession?

Are we headed for a recession?   It sure looks like it.

Markets are cyclical, and often what drives these cycles is a pattern of over-consumption and over-borrowing, following by a lean period, when people retreat on spending.   We've seen this throughout history.

In the 1950's people bought more and more elaborate cars, culminating in the gaudy be-finned monsters of 1957-58, slathered in chrome and loaded with big gas-hungry V-8s.  By 1959, the market lost steam, and suddenly people were buying Ramblers and Studebaker Lark's. The "Big-3" introduced lines of small cars - the Falcon, the Valiant, the Chevy II - into the recessionary market of 1960.   By the late 1960's, big, gaudy, gas-hungry cars were back, but withing a few years, the cycle repeated itself, and a new line of subcompact cars - the Vega, the Gremlin, the Pinto - came out just in time for the stagflation recession of the 1970's.

The pattern of expansion and contraction is normal and nothing to be worried about too much - but it is a pattern one should expect and not be surprised by.   For some reason, some politicians believe that nothing but growth, growth, growth, should ever be allowed - as if governments could control economies - and they will try to tweak and goose the economy through various ill-advised means, to keep the party going even longer.  The problem is, like that "one more drink" or "nightcap" at the end of the night, it just insures your hangover will be worse the next morning.

Much of what causes recessions - and extends them - is psychological, too.  If people feel money is tight, they spend less.  For example, as a retiree with a 401(k) plan, I look at my accounts every day and see that I made a pile of money one month - even though I was withdrawing money to pay for my living expenses.  My net worth is increasing, even as I spend the money.   Sweet!   But suppose the market goes down?   I look at my investments and think, "Gee, I might run out of money someday, I'd better cut back on spending!"    Multiply this times millions of people, and it adds up.  The snowball effect kicks in, and people cut back on spending, which in turn causes companies to lose money, driving down stock prices and causing layoffs, which in turn encourages people to stop spending.

A reader writes, "Why do you think a recession is coming?"   And there are many reasons why I - among many others - think this.  Mostly it is having lived through this market cycle multiple times in my life.   The most recent example, of course, was in 2008, little more than 10 years ago.   The pattern we saw then was about the same as the pattern we see today.

Here are some signs the economy is slowing down:

The Inverted Yield Curve:  Many economists call this a "predictor" of recession.   When long-term yields are lower than short-term yields, something isn't quite right with the economy.   Basically, investors are saying that interest rates will fall in the future.  It has inverted many times in the past, including before the recession in 2008.  It recently inverted in late 2018, which spells trouble for 2019 and 2020.

Slowing New and Used Car Sales:  After the recession of 2008, people stopped buying cars.  You may have noticed that GM and Chrysler went bankrupt as a result.  Since then, car sales took off, as there was a lot of pent-up demand for cars, after people "did without" for so many years.  And the cars (trucks and SUVs mostly) have taken off in features and price.   As a result, the length of loans has increased, as well as the average price of a new car.   But like any product cycle, once demand is saturated, people stop buying, mostly because they have to work on paying off the car they just bought.  Sales of new and used cars have declined in 2019, perhaps not by huge amounts, but nevertheless a decline.

Trucking Companies Going Bankrupt:  Just last year, trucking companies scrambled to find enough drivers to haul their loads.   There was a driver shortage!  What to do?   Well, fast-forward 12 months, and the amount of freight being hauled is declining, and hundreds of trucking companies have gone bankrupt.   This is a "tell" of the economy, in that when shipping drops off, it means commerce is retreating.  People are buying less stuff which means a retraction in the economy, which, if this goes on for more than a couple of quarters, means a recession.

During our trip this summer, we noticed a lot of trucks carrying "light loads".  Many flatbed trucks were hauling half-loads or even automobiles (which is not a profitable proposition for a flatbed, but it beats "dead-heading").  Truckers we talked to grumbled about business.   It seems like the glory days of 2018 evaporated rather quickly.

Railroads Reporting Steep Declines in Shipments:  According to many sources, America's railroads are already in recession.   Bear in mind that since the bad old days, America's railroads have returned to profitability and have cut costs, with CSX leading the way.   Intermodal transport - where containerized cargo is transferred seamlessly between ship, rail, and truck, has increased rail traffic considerably - and made it quite profitable.   But as with the trucking industry, if people stop buying stuff, then traffic falls off.   And the decrease in rail traffic is a sure sign that people are not buying as much as they used to.

The Tariff War:   It has yet to come into full swing, but tariffs are already affecting many American businesses, and starting to affect American consumers.   Tariffs mean only increased prices for everyone.  When you put a tariff on imported tires, for example (as Obama did) it doesn't mean that Americans will flock to cheaper American tire brands, but only that American tire producers (the few that remain) will increase their prices to match the tariff'ed imports - and yield windfall profits, for a time.

Excessive Consumer Debt:  The decrease in demand for consumer goods, cars, and the like is due in part to the staggering amount of debt Americans have taken on in the last few years.  In addition to credit cards, consumer loans, and car loans, are student loans - also at record highs - and mortgage debt, which has crept up as housing exploded in certain communities.   When people struggle to pay their debts, they are forced to consume less.

We saw this during the last recession.  Again, people psychologically feel wealthy as the value of their investments and homes increase.   They go out and spend, and then realize they have a credit card crises.   So they refinance their house and take out cash to pay off other debts, and then feel good about themselves and spend more.   Eventually, however, they run out of money to borrow.  And if housing prices decline, the problem becomes acute.

Excessive Institutional Debt: Companies are taking on debt like never before, as companies "leverage" themselves with debt.   Every day, another company or retailer goes broke, and the media blames Amazon, only incidentally mentioning the staggering debt load the company had to service.  Companies go broke, people lose their jobs and are less inclined to spend.   Investors, losing money on their bonds, panic and cut back on spending.   The cycle feeds upon itself.

Again, this is a pattern.  We saw this back in the 1980's with Michael Milken and his "junk bonds" which oddly enough, turned out to be junk (wow - didn't see that coming!).  In each iteration of this boom/bust cycle, we see this pattern - new sketchy financial instruments being touted, and people saying, "This time, it's different!"   Yet it turns out to be the same.

Increased Delinquencies in Debt Payments:  Not only is consumer debt at an all-time high, people are struggling to pay it back.  Delinquencies in credit card debt payments reached a seven-year high this Spring, but have improved, somewhat, in recent months.  Of course, we know what late payments on credit cards means - you are socked with the "punishment rate" of 25-30% or more, and you can never pay back the debt as a result.   This does not bode well.

Wall Street's Once-Again Fascination With Bundled Debt Instruments:  The last time around, in 2008, Wall Street threw gasoline on the debt fire by "bundling" mortgage debts together and selling these as investment vehicles.  Too late, people realized that bad debt bundled together does not make for good debt, and the whole thing collapsed when these funny-money, nothing-down, payment-optional, "liar's loans" turned out to be bad debt.   Who knew?

This time around, it is bundled consumer debt that is being sold as an "investment" without too many people asking pointed questions as to whether any of this debt is good.   Once again, as in the mortgage crises, the people making the loans (mortgage brokers, bankers) are paid a commission on how many loans they make, not on how many good loans they make.  Car makers, wanting to sell cars, increasingly overlook issues with debtors and approve loans, often at higher rates that almost insure default.   It is the same-old, same-old, only in a new candy wrapper.

The Brexit Fiasco:  One would think that the looming Brexit fiasco would affect only the UK, but in this world of interlinked markets, if one country goes into recession, it affects others. And many are arguing that a "no deal" Brexit (which looks more and more likely, as the new PM wants to drive the car off this cliff) could send the UK economy into recession.

Trade is what drives economies, and indeed, economics is the science of trade.  When people buy and sell things, that is the economy.  The UK, being an island country, like Japan, has to trade to survive - it is how the "British Empire" was created, through trade and various trading companies, which once ruled half the world.   If Britain "goes it alone" it will find the cost of everyday goods increasing significantly, and commerce declining as a result.  Already, many manufacturers are moving production to other countries, or delaying or abandoning expansion in the UK due to the uncertainty of tariffs.  Brexit may not be the sole cause of the next recession - indeed none of these factors listed here would be the sole cause - but rather a factor, which when taken in combination with the others, leads to a retraction.

Slowing Real Estate Sales and Prices:  In the last few years, a few "hot markets" have emerged for real estate, as local conditions drove prices through the roof.   In the tech sector, overheated and overpriced companies paid huge salaries to young tech workers, even as many of these companies lost money.   High salaries are fine and all, but they often just lead to higher prices on everything from food to cars to houses - which means the high salary evaporates pretty quickly.  In any market, you are bidding against your co-workers for housing, based on how much income you have to spend.  The big paycheck only means you spend more on housing - you don't come out ahead, really.

But recently, prices have cooled off, and bidding wars for housing in the hot markets has declined.  In special markers, such as Vancouver, where Chinese expats bid up prices to the stratosphere, government policies (of both Canada and China) have dampened the party, somewhat.  If you are a fan of economics - or have just lived through numerous housing bubbles - this is not unexpected.  There is no such thing as "unafforable housing" or unsold houses with no buyers.  Everything in the marketplace finds a buyer at a price - even at a loss.

(This reminds me of a conversation I had with a young man.  He had been reading "sponsored content" online and read one of these click-bait articles showing an image of a new car storage lot, claiming that car makers have "unsold inventories" of cars that they crush after making, because no one wants to buy them.   This is, of course, bullshit.  Every car finds a buyer, eventually.  If a car is selling slowly or is left-over after the model year, it is slapped with a sale price, or sent over to the used car lot and sold as "used" much as Audi did after the TT fiasco).

Eventually, people stop buying.  Either they run out of money and can't afford to buy the ever-increasingly priced houses, or they lose their jobs and sell out, increasing the inventory on the market.  It may seem "unfair" that for 5 years or so, housing prices skyrocket, but eventually housing finds a new equilibrium, as it did in 1989 and again in 2009 (and as it has, many times in the past, in the Bay area).  I suspect we are seeing a new "adjustment" in the marketplace, which will continue into 2020.

Again, this becomes a problem for people who want to borrow against their home - or people who have mortgaged their home and find it is now worth less than the balance on the loan (a surprisingly large number of people are still underwater from the 2009 fiasco, if you can believe that!).  This decreases consumer confidence and causes people to pull back from spending more money, again, adding to the snowball effect.

A Slew of Money-Losing IPOs:  The stock market increasingly appears to be a rigged game these days, with clever CEOs starting companies, lining their pockets with cash, and then cashing out with specious IPOs for companies whose "technology" involves idiotic things like car rental, food kits, subletting office space, or whatever.   People are so desperate to invest in "the next Microsoft!" that they will throw money at anything, hoping it sticks.   Eventually, as we saw in the previous "dot com" boom-and-bust cycles, a few companies stick around for the long haul, but many more bite the dust, taking out the dreams of the small investor in the process.   These small investors (and the unemployed workers from the failed dot-com company) in turn spend less, adding to the shrinkage in the market.

European Economies in Recession: Some are arguing that Europe is headed for, or already in, recession.  Bear in mind that some economies in Europe have been in trouble for years now - Greece and Italy come to mind.   Political upheaval in France certainly doesn't bode well.  But Germany?  The juggernaut of the EU economy?  In recession?   This really is a bad sign.  Bear in mind that many economies throughout the world are already in recession and have been in a bad way for many years.  Japan, for example, really has stagnated in the last decade.

Slowing Economy in China:  The "China Miracle" may have been a bit overstated.  It turns out that the Communist command-economy model isn't quite dead, and China has been making its stated growth goals simply by announcing they have been achieved.   In many provinces, governments have built entire cities of empty buildings in order to meet the central government's growth mandate. And a lot of this was paid for with "phantom debt" which is off-the-books.   It is like an entire country, run according to Enron accounting standards.

Even by inflated government reporting, China's economy has slowed recently.  The trade war is no doubt a part of this, but also it is possible we are seeing the start of the eventual collapse of voo-doo accounting practices.

Political Upheaval:  Brexit Protests, Yellow Vests, Hong Kong Riots, Neo-Nazi demonstrations, worldwide migration, continuing war in the middle-east, and of course, impeachment proceedings (as well as a contentious election cycle) all add to the level of psychological discomfort and uncertainty that people are experiencing.   This may not be a major factor, of course, but every little bit adds to the pile.

Erratic Market:  The stock market has shot up in recent years, often for reasons that defy logic.  When Trump was elected, many thought he would usher in a new age of deregulation and union-busting.  But what he has brought instead was chaos.  Before the crash of 1929, the market saw wild swings, as sentiment went from euphoria to depression, almost as if drugs were involved.   Today, we see the same thing, with the market going up and down hundreds of points based on a tweet or the announcement of a potential new trade deal, or the quashing of same.   Unstable stock prices are never a good sign.

The Inevitable Cycle:   Economies do not expand linearly forever.  Over time, the general trend has been for expansion, but this does not occur in a uniform fashion, worldwide, and there are historic incidents where the economy has retracted, regrouped, and then re-expanded.   It is, in a way, like pruning a bush or tree - you cut away the excess limbs, the rotted branches, and whatnot, and the next year, it grow back even better than before.   But the longer you delay this pruning, the worse the overall growth will be.  This is, of course, cold comfort to someone living on the rotted branch.

After eleven years of growth - the longest bull market in history - we are due for a retraction.  Despite the ravings of our insane President - a failed businessman who has seen his own personal fortune rise and fall over the years - we cannot expect the economy to grow indefinitely.  All good things must come to an end, or at least take a breather.   It's about time.

* * *
Again, each of these factors, taken alone, isn't enough to trigger a recession or signal the coming of one.  But taken together, they paint a picture of a retracting economy, as people reach their borrowing limits, feel uncertain about the economy, and start to spend less in the coming months.

The exact timing of such a recession is, of course, impossible to predict.   It could be tomorrow, it could be next year.  It might not be for more than a year, although I doubt at this point it could wait that long.   If you could time this to the minute, you could make a ton of money, as some clever people did the last time around, when they saw the mortgage-backed securities fiasco collapsing and shorted that investment.

Of course, us mere mortals don't have the intelligence or the experience to time the market.   We don't have access to the relevant data, either.  So what does the little guy do to prepare themselves for the inevitable?    This depends all on your personal situation and station in life.

If you are already in debt over your head and owe more on your house than it is worth, there isn't much you can do, other than prepare for an eventual bankruptcy, and plan on starting over again, once the dust settles.   Believe it or not, some people actually do this on purpose, borrowing as much as possible, living the high life, and then expecting it all to go bust, eventually.   They know, too, that within a few years, those same banks they stiffed last time around will be the first ones in line to offer them more loan money.  And you wonder why we have recessions.

But for the rest of us, what we should do is what we should have been doing all along, which is to say, investing money, diversifying your portfolio, paying down debts, not taking on debts for consumer goods or other silly things, and having a financial plan in place.   If you do this, odds are, you will survive the next recession just fine.   Bear in mind that within a year of the 2019 nadir, the stock market had recovered to its pre-recession levels.  And within a few years, housing prices in all but the most overheated markets had recovered somewhat as well.   If you bought in the months before it all collapsed, odds are you are still underwater.  But people who bought in 2004 are probably sitting on positive equity by now.

Your station in life - and by that I mean your age - also affects your strategy.  If you are young and starting out, selling out of the market might make less sense.  As I noted before, some elderly friends of mine sold out at the nadir of the market, convinced that the stock market would evaporate entirely, now that we had a black President.   What they did, in effect, was to lock in their losses, as the market rapidly recovered, once people realized that many companies were still making money.  They cut their retirement portfolio in half, and never recovered.  Timing the market is not for us mere mortals.

However, for someone in my age bracket, who is living off their 401(k) money, it might make sense to liquidate some assets now.   Last year, I sold out enough stock and put it into a money-market account in my 401(k) - so it is not a taxable event.   In the next few years, I will need this money to live on, and if the market goes down next year, I would have to sell stocks at their nadir to live on.   It makes more sense to have a few years of income in cash, as the potential "gain" from the last year (which has been flat and erratic) is pretty small compared to the risk of a coming recession and having to sell low.

Mark, on the other hand, is five years behind me in this cycle-of-life, and we can afford to leave his investments in a panoply of mutual funds, stocks, and bonds, for the time being.   It will be scary, to be sure, to see these drop in value by half, but bear in mind these are paper gains and paper losses and not realized until the day you sell them and realize a profit or loss.   It is like a roller coaster, and often the peaks and valleys are mere transient conditions that can be waited out.  If you sell low and buy high, on the other hand, you will go broke.   So we will leave his investments alone and hopefully by the time he needs the money (and I have exhausted mine) these investments will have recovered.   All you can do is hope for the best.

Of course, this time around, we are far better situated in that we have no debt to service, and thus can cut way back on spending, if we have to.  Being in a cash situation, we also can take advantage of undervalued investments, if the timing is right.   When the shit hits the fan, you want to be the guy who is debt-free and has cash to invest.   Those were the folks who snapped up those foreclosure houses in Florida, and bought those undervalued stocks in March of 2019.

And it will happen again, as sure as the sun rises in the East.   But exactly when, I cannot predict.