Hey VettaFi Voices, the question this week is “Have we avoided recession?” There are differing opinions all around, but some reputable sources like Goldman Sachs are saying it’s increasingly unlikely. Yet the Fed is going to be raising rates further, from what it looks like, because inflation is higher than they want. And many have warned that continuing to raise rates risks sparking a recession. What do the VettaFi Voices think about the matter?
Todd Rosenbluth, VettaFi director of research: I’m not the best reader of economic tea leaves, but investors seem to still expect moderate growth based on my initial glance of some ETF flows. For the past month, the low-cost core equity ETFs, like the iShares Core S&P 500 ETF (IVV), the Vanguard S&P 500 ETF (VOO), and the Vanguard Total Stock Market ETF (VTI), have led the way.
But the iShares MSCI USA Quality Factor ETF (QUAL) added $860M and the Pacer US Cash Cows 100 ETF (COWZ) pulled in $550M. High quality ETFs are focused on companies with strong free cash flow, consistent earnings, and strong balance sheets. These tend to better during periods of moderate growth and not a recession. I would think more defensive ETFs like low-volatility ones or high-dividend ones would be gaining traction if a recession was more imminent.
But there’s still fear out there. The SPDR Bloomberg 1-3 Month T-Bill ETF (BIL) is the most popular bond ETF and you can’t get shorter in duration than this ETF. The WisdomTree Floating Rate Treasury Fund (USFR) also gathered over $800 million with the floating rate as a major appeal.
So there’s concerns about rates potentially climbing higher or investors are looking for safety given the strong yield,
Economic Changes
Jen Nash, economic and market research analyst at VettaFi: At the beginning of this week, I checked the CME Fed Watch tool and there was a 52% likelihood that the Fed was going to raise rates at their Nov. 1 meeting. However, since then, we have seen reports on JOLTS, GDP, PCE, and ADP employment. The likelihood for a rate increase at the Nov. 1 meeting has now fallen to 40%, and the majority sits at the position of rates remaining the same.
One more big piece of data is still to come out this week: the August jobs report. As of today, the forecast is expecting 170,000 jobs to have been added in August, which would be the smallest monthly gain since December 2020. Combine this with the recent JOLTS news that job openings fell below 9 million for the first time since March 2021 and we are definitely seeing the labor market losing steam.
Rosenbluth: Thanks. So slow economic growth, but still economic growth it seems.
Nash: But to answer the question — I’m not 100% convinced that we have avoided a recession. There are still a handful of leading indicators saying that that is where we are headed. The 10-2 year Treasury yield spread has been negative for over a year. The Conference Board Leading Economic Index has fallen for 16 straight months and continues to suggest economic activity is likely to decelerate in the months ahead.
Consumers Cooling Off
The rapid improvements in consumer attitudes over the last few months have also moderated, according to the Michigan Consumer Sentiment Index. Consumers saw inflation coming down but the latest CPI and PCE reports showed that the inflation battle is not over. To quote the Conference Board regarding the latest decline in their consumer confidence index: “consumers were once again preoccupied with rising prices in general, and for groceries and gasoline in particular.”
Rosenbluth: We had real GDP at 2.1% in Q2.
Nash: Exactly. That’s what we saw in Wednesday’s GDP report with the downward revision from 2.4% to 2.1%. Economic growth but slower than initially thought, which must have been a good sign for the Fed.
Rosenbluth: Roxanna Islam Swan noted that retail sales in July increased 0.7% compared to June with the Amplify Online Retail ETF (lBUY) and the VanEck Retail ETF (RTH) impacted
Dave Nadig, VettaFi financial futurist: So, this was a decent part of my recent conversation with Cameron Dawson and Barry Ritholtz recently. Quite a few economists (David Rosenberg, notably) would argue that the two quarters of negative growth we had in 2022 should have “counted.” However, the reality is that we have a very different economy than we did when NBER set up their standards for when we put the big gray bars on the FRED charts.
Questions of Measurement Around Recession
The combination of confounding effects in how we measure key elements of the economy means the question is almost meaningless. Consider GDP (flawed, incomplete), inflation (heavily modified to track long-term policy trends, not short-term economic swings), and labor (massively adjusted to smooth data, and deeply unrepresentative of the shift in how labor works in the last decade).
- To me the bigger questions are the following:
- Are people spending? (yes)
- Are corporations generating good margins? (yes)
- Are global supply lines and international trade functional? (mostly)
- How much is all of the positive money velocity being driven by leverage? (quite a bit)
It’s the latter one I think we should be most concerned about, whether its debt to GDP or debt service to income.
Obviously those send someone conflicting messages, but the rapid reflation of consumer debt payments – even if low compared to the last decade — is a bad thing, especially in a higher interest rate environment.
Nash: Todd, retail sales have increased the past four months and Q2’s GDP growth was largely driven by consumer spending. So, yes we are seeing people spend money. A lot of headlines have said that Barbie, Taylor Swift, and Beyonce have been boosting our economy all summer.
Nadig: People always find something to spend on if they’re feeling … spendy. That’s the technical term right?
Heather Bell, managing editor, VettaFi: Personally, I need very little excuse. Spendy works for me, Dave.
Rosenbluth: During a mid Aug webcast with Nationwide, we asked advisors “What is the most important issue impacting your investment decisions in 2023?”. Economy/inflation was top choice with just under 50%, followed by market valuations (26%) and then interest rates (17%). Jobs/employment was a distant fourth. I think a potential recession still is a fear for many advisors.
Student Loan Repayments Restarting
Nash: Do we think consumers are going to continue to spend like they have been? There’s a lot of talk about the impact student loan payments will have once they start back up.
Bell: I’ve been reading that that will really hurt retail/consumer discretionary. Here’s one of the articles.
Islam: Yes, consumers have been surprisingly strong but after months and months of this environment it won’t last forever. A lot of the boost we saw in July can be attributed to Amazon Prime Day and all the other competing sales. Personal savings rate went back down to 3.5% in July, which has been the lowest level so far this year. For reference, this was in the 9% range pre-pandemic
Nadig: There’s a ton of unknowns. The SAVE plan only covers folks making under $60k, so that has no impact at all. The bigger issue is frankly suburban professionals who have >$100k in debt and have been on a multiyear lifestyle binge. That spending will be going away.
Nash: So back to your question, Dave, are people spending? Yes they are right now but they won’t be later on this year
Nadig: (It’s also worth nothing that savings rate has gone from 8.8% in 2019 to 3.5% in July… that can’t continue forever)
Impact on Housing Markets
Islam: Not everyone needs to buy a house or car, but as more months go by, there will be more people who will need to do this. And the people who bought or refinanced their first home near the pandemic are paying less than 3% on their mortgage and have to potentially pay more than 7% if they move to a larger house. That’s a portion of people who are going to be spending less moving forward because of that.
I think corporations may start to feel it soon in their stock prices too. Smaller companies have already felt some pain. A lot of large-cap companies are still doing well, but we saw a lot of tech companies pursue layoffs in hopes of reducing expenses. After a few quarters if those efficiencies aren’t realized, those stocks are going to be punished.
Nash: Not only are future home buyers subject to the historically high mortgage rates, home prices are also at historically high levels. Existing home sales have been in an overall decline since the beginning of 2022 due to the lack of inventory. Homebuyers who secured low rates are reluctant to sell just to end up with a mortgage rate twice as high as what they have now.
Nadig: Barry Ritholtz called that “the Pandemic’s new landed gentry”
Islam: Yeah I’m feeling it hard right now — I finally committed to a storage unit this week because I’m facing the fact I’ll have to live in a smaller house for longer!
Nash: I may need to do that soon! The lack of inventory in existing homes has led to gains in new home construction sales which could impact ETFs like the Invesco Building & Construction ETF (PKB), the iShares U.S. Home Construction ETF (ITB) and the SPDR S&P Homebuilders ETF (XHB).
An Unusual Situation
Bell: Could we be in for an extended malaise? Would it be better to just have a recession and get it over with? Because it’s kind of looking like “Waiting for Godot” these days on the recession front…
Islam: Personally, I’m leaning toward there won’t a true recession. But I think it’s a more complicated situation than if/when a recession will occur, which I think is what Dave was saying earlier too. It may begin to feel like we’re in a recession because people’s financial well-being is diminishing – even if we’re technically not. But maybe, in a way, it would be simpler for there to be a recession. Maybe that would be less surprising and easier to understand than what’s happening today.
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