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The Recession No One Will Discuss

As Equity Investors Rush to Exit

Employment – Weaker than the Narrative

The markets yawned at April’s headline Payroll Survey number (+428K) despite the media’s characterization of the report as “strong.”  That’s because, upon further analysis, the most charitable description would be, in our view, “mixed.”  In fact, “worrisome” would be our best characterization.   Here’s why:

  • The headline payroll number comes from a monthly survey of large and mid-sized businesses.  Because it does not survey small businesses, BLS “adds” jobs that it attributes to that segment.  This is called the “Birth-Death” model.  For April, +160K jobs were added through the “magic” of this “adjustment.”  This means that the net new jobs that were actually counted in the survey were +268K, a number that, in our view, would have disappointed markets, as it would have been interpreted as a significant slowing from the prior month and below the +400K Wall Street consensus.  The chart above is from ADP’s employment report released on Wednesday (May 4).  Note the large fall in small business employment in April.  Because ADP is America’s largest payroll service company, this data is highly credible.  If this more realistic -120K were used in place of the +160K (“Birth-Death”), the net for the Payroll Survey would have been +148K, not +428K!  And “recession” talk would have been all over the Street.
  • The Household Survey said net employment actually contracted by -353K in April.  We wouldn’t characterize that as “strong.”  Worse, -651K full-time jobs in this survey vanished.  While the Household Survey is somewhat more volatile than is the Payroll Survey, it tends to lead at cyclical turning points.  It did so in February ’01 and in December ’07.  That’s because small businesses are the heart of America’s economy and react to economic conditions much faster than large businesses. 
  • A survey conducted by the National Federation of Independent Businesses (NFIB) suggested that small businesses are paring back their hiring plans.  In addition, job postings on Indeed.com are falling.  These, too, tend to be a leading employment indicators.
  • The Household Survey is the one on which the unemployment rates are based.  The headline unemployment rate (U3) held steady at 3.6%, slightly disappointing the consensus view that it would fall to 3.5%.  The Labor Force Participation Rate (LFPR)(the percentage of the working-age population with a job or actively looking for one) fell from 62.4% to 62.2%.  As a result, the labor force declined by -363K.  Strong labor markets do not see such declines. 
  • 665K people who had jobs in March but lost them in April simply exited the labor force.  This phenomenon is a characteristic of weakening, not strengthening, employment trends.  Had these folks not exited the labor market and had they begun to look for another job (i.e., had the LFPR had held its March level), the U3 unemployment rate would have risen to 3.8%. 
  • The broader unemployment measure (U6) which includes those working part-time, but wanting full-time, rose to 7.0% from 6.9%. 
  • Here is an interesting observation from Economist David Rosenberg: “…employment at the employment services sector declined 10.5K…What do you think it means for the job market outlook when the headhunters start chopping their own heads?”
  • Our conclusion here is that we are just beginning to see the tip of the iceberg regarding employment.  We expect significantly more weakness over the next few months.

Equity Market Volatility- A Sign of the “Bear”

The table shows the changes in the major indexes from their nearby peaks and for the week ended May 6.  Despite the relatively small percentage changes for the week, volatility was the market’s major characteristic.  The DJIA rarely moves more than 1% in a single session, much less 2% or 3%.  But the DJIA accomplished that in back to back sessions on Wednesday (+2.8%) and Thursday (-3.1%).  There were similar moves for the Nasdaq (+3.2% and -5.0%), for the S&P 500 (+3.0%, -3.6%) and for the Russell 2000 (+2.7%, -4.0%). 

 Pct. Chg. from PeakPct. Chg. for May 6 week
S&P 500-14.0%-0.2%
Russell 2000-24.7%-1.3%

As noted, there was a lot of volatility for a rather benign week/week result.  That kind of volatility usually occurs in “Bear” markets.  And look at the middle column of the table; Nasdaq and the Russell both in the jaws of the “Bear” (down more than 20% from the nearby peak), while the S&P is in “Correction” (down more than 10%). 


Readers of this blog know that we believe that recent Fed and market actions will push the economy into a recession in a more compressed time frame than one would expect from past tightening cycles.  That’s because the markets have, in a matter of just over a month, fully implemented the Fed’s “terminal” rate, a rate that will take several more 50 basis point (0.5 pct. point) rate hikes.  In past tightening cycles, the Fed never issued “forward guidance,” so markets never pushed rates much higher than where the Fed was.  As a result, because markets have fully implemented the Fed’s 18-month plan, in this tightening cycle, the recession will appear earlier than in past tightening cycles.  We are confident in this call and the incoming data continue to confirm our view.

  • The chart shows the breakdown of Q1’s preliminary real GDP. 
  • In Q1, the 2.7% gain in consumer spending was supported by a drawdown in consumer savings.  The savings rate is now lower than is was pre-pandemic, so that cushion for spending has now been depleted.  Furthermore, 80% of Q1’s growth occurred in January, so the handoff to Q2 was quite weak.
  • In addition, despite rising wages, average real weekly earnings continue to contract (see chart) and are weaker than they were in the Great Recession.  With savings depleted, prices rising faster than wages, and interest rates up dramatically, rising levels of consumption don’t appear to be a good bet.
  • While the markets seemed to initially ignore the -1.4% real GDP print in Q1, the chart shows the percentage change in real GDP by month.  Note that we haven’t seen positive real consumption growth since October when consumers purchased “early” for the holiday season due to the then rampant “shortages” narrative.
  • For the past several months, the University of Michigan’s Consumer Sentiment Surveys have indicated significantly lower intentions to purchase big ticket items.  We note that spending on durable goods fell -0.9% M/M in March, is down two months in a row (and down in four of the last five).  Non-durable goods, too, were off -0.3% in March after falling -0.7% in February.
  • The housing market is weakening.  New and Existing Home Sales are falling.  Remember, people buy homes, cars and other big ticket items based on the monthly payment.  Given the rise in home prices (the median home price rose from $326K to $375K over the past year) and the rise in the 30-year fixed mortgage rate (3.1% to 5.5%), the home the consumer could have purchased a year ago for $326K with $65K down and a monthly payment of $1,115, now would cost $375K, would require $75K as a down payment, and the monthly payment would have skyrocketed 53% to $1,703.  The chart shows what has happened to mortgage applications to purchase as a result of rising rates.
  • Furthermore, mortgage applications to refinance an existing mortgage have fallen off a cliff.  Refis are often a source of liquidity for major purchases, another reason we believe we will see, very soon, a notable slowdown in consumption.

Rest of the World

Needless to say, Europe and China have major issues of their own.  Europe faces serious energy issues due to the war in the Ukraine.  Industrial Production is falling in France and Germany.  And China’s economy has stalled due both to the implosion in their real estate sector and to the lockdowns of their major cities (zero-tolerance Covid policy).  The chart of subway traffic in both Shanghai and Beijing shows the impact of those lockdowns.

The Case For Bonds

In the first four months of the year, we have seen dramatic falls in both the equity and fixed-income markets.  First Trust did a study of what has historically happened in ensuing time periods when stocks and bonds fall simultaneously.  There have been 16 such episodes since 1977.  The table shows that a year after such episodes, 73% of the time, equities have risen in value, while that number is 100% for bonds. 

                                    ———–Percent Positive———       —————Return——————-

 6 mos.12 mos.6 mos.12 mos.

The last table shows eleven drawdowns in the bond market of more than 3% since 1979 and how many subsequent months it took to reach a new high; less than a year in every case.

The incoming data tell us that a recession is unfolding.  Once that recession is recognized by the business community, the Fed will be forced to stop its tightening.  If the Fed never gets to its stated “terminal” rate, markets, which have already priced-in such rates, will have to adjust to a lower one.  Under these conditions, bonds look cheap!

Robert Barone, Ph.D.

(Joshua Barone contributed to this blog)


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