Economic Boom Time in the Go-Go 2020s
This week, Q4 U.S. GDP was reported at what the financial media touted as a “booming” 3.3%. The headline result was below Q3’s 4.9% blowout rate, but was still extremely strong, and miles above the 2% consensus estimates of economists. So, with inflation measures to date having fallen substantially from peak, the Fed seemingly close to initiating a policy easing cycle, the S&P 500 at new all-time highs, and the GDP economy “booming,” what’s not to like? Are we in the clear? Will Goldilocks economic conditions reconstitute and prevail indefinitely? Are we now fundamentally economically healthy? Are we set to avoid a hard landing in a newly reaccelerating economy? In HAI‘s view, the answers are no, no, heck no, and don’t bet on it.
As to that “booming” GDP report, it came with some disturbingly large fleas. To begin with, the government spent—and spent big—to facilitate that growth. In fact, the substantial $329 billion dollar boost in Q4 U.S. GDP growth actually would have been impressive had it not been accompanied by an even larger $510 billion increase in the U.S. budget deficit. In other words, each dollar of GDP “growth” was bought and paid for by an expensive $1.55 in mounting budget deficits. Growth at the cost of fast-tracking an insolvency crisis largely takes the luster out of mainstream financial news enthusiasm.
Further, the insolvency math underpinning the “strong” GDP report wasn’t the only problem. The closer you look, the more curious the GDP results become. For example, compare the Chicago Fed National Activity Index for the same Q4 of 2023. The Chicago Fed’s National Activity Index is widely considered to be among the most accurate and highly respected national economic activity gauges. For the three months constituting Q4 2023, their National Activity Index was horrendously weak. The index was negative 0.68 in October, nearly flat at 0.01 in November, and down 0.15 in December. The index in no way reflected the sort of strength implied by a 3.3% Q4 GDP boom.
Additionally, banks have been reducing aggregate credit to the private economy, and real bank lending growth has trended negative. Historically, that’s happened only in or immediately following a recession. Consequently, it’s not surprising that while government spending was up, up, and away, regional business backlogs reported by individual Federal Reserve Districts (they reflect the nation when combined) flagged recessionary industrial conditions.
Meanwhile, indications are that the nearly $60 billion in credit card and nearly $20 billion in Buy Now, Pay Later debt taken on in December to facilitate especially happy holidays is already experiencing a nasty payback. According to Bank of America debit and credit card data, the party may already be over. As the bank said, “Total card spending per household was down 3.0% year-over-year in the week ending January 20.” Most concerning, BofA said that, “spending on discretionary services—entertainment, restaurants, lodging and airlines—was the most affected.” That’s a problem because it’s that very same discretionary services spending category that has been a solid contributor to whatever economic resilience remains in the private cyclical economy.
Furthermore, credit card charge-off data from Capital One shows a clear trend toward accelerated deterioration. Charge-offs have trended from 3.22% in Q4 2022 to 4.4% in Q3 2023 to 5.35% in Q4 2023. In December, the last month of that same 4th quarter, charge-offs leapt to 5.78%, meaning that the deterioration trend remains substantial and was even significant intra-quarter. Again, this just isn’t consistent with a healthy 3.3% GDP boom in the economy.
We also know that government and the non-cyclical education and healthcare sectors are now disproportionately responsible for current job creation. In fact, total private payrolls less education and healthcare is continuing to trend lower and is now growing at roughly a quarter of its historical average rate. Again, such pronounced weakness amid an ongoing weakening trend in the most cyclical labor market is inconsistent with the booming economy narrative and a 3.3% annualized rate of GDP growth.
Likewise, in another material blow to what increasingly appears to be merely a shaky facade of supposed economic strength, highly respected Bloomberg chief economist Anna Wong openly declared this week that the job market is “not as tight as jobless claims suggest.” That’s important. Historically low levels of jobless claims throughout the Fed’s tightening cycle have been used repeatedly as the undisputed centerpiece of the non-recessionary, extremely tight labor market thesis. However, according to Wong, “we don’t think the jobless-claims data should be taken at face value. Our analysis finds claims currently are suppressed by a historically low percentage of unemployed persons applying for benefits—due to a low eligibility rate, combined with a low income-coverage ratio from benefits due to inflation.” According to Wong, if adjusted to the current conditions, “continuing claims would have been about 500k higher over the past year—on par with their level before the 1980, 1990-’91, and 2001 recessions.” Wong continued that despite the narrative, “the labor market has loosened notably over the last year.”
Lastly, also out this week, the leading economic indicators, as reflected by the Conference Board’s Leading Economic Index (LEI), continue to warn of recessionary risk dead ahead.
As of this week’s December update, the LEI has now fallen for 21 straight months, a streak only one lonely month off of the all-time record decline of 22 months during the Great Recession. In addition, for 15 straight months the LEI has weakened substantially beyond and remained below the index’s recession threshold level that has perfectly predicted all eight recessions in its 60+ year history. In short, from a historical perspective, the LEI’s take on the forward economy is unambiguously recessionary.
To put the unhealthy recessionary signal of the LEI into perspective, despite palpable ‘soft landing’ enthusiasm throughout the financial media landscape, the LEI aggregate index is currently reading below index levels seen back in 2006. Furthermore, the LEI’s deeply recessionary annual growth rate of negative 6.9% is completely decoupled from current Real GDP to an extent seen only during past recessionary episodes.
Given the magnitude of the recessionary signaling of the leading economy, we need to maintain vigilance over the risk of impending recession even if it has yet to manifest. Indeed, it may be wise to take Justyna Zabinska-La Monica seriously. She’s the Senior Manager of Business Cycle Indicators at the Conference Board, and she warns that “Overall, we expect GDP growth to turn negative in Q2 and Q3 of 2024.” She further cautions that the LEI continues to both “signal underlying weakness in the US economy” and “signal the risk of recession ahead.” We’ve quoted economist David Rosenberg’s apt simile in an earlier HAI, but it bears repeating. Given the consistent signaling of the leading economic indicators, to ignore current recession risk because a recession hasn’t happened yet would be akin to “expecting no winter because there hasn’t been any snow in December.”
To help combat what HAI fears is little more than reckless economic optimism that won’t age well, let’s draw from HAI favorite economist Lacy Hunt’s latest missive. According to Hunt, 2023 was just the eighth year in history in which the U.S. suffered “negative net national savings” (NNNS). NNNS is when the Federal Budget deficit exceeds the sum of both private savings (household and corporate savings) and foreign savings (the inverse of the current account deficit). A condition of positive net savings is, as Dr. Hunt puts it, “a requirement for an increase in the capital stock and a better way of life.” In short, without positive national savings, “resources are insufficient to cover depreciation, and the capital stock, critical for the standard of living, shrinks.” In other words, if we “grow” the economy amid a condition of NNNS, we do so at the expense of living standards, real prosperity, and future growth.
The seven other instances of NNNS were entirely distributed in years in and around the Great Depression (four years,) and in and around the Great Recession (three years). Well, as of 2023, we’re back on the NNNS road to ruin. Alarmingly, however, this time we’re already back on the ruinous NNNS road without a next “Great” hard-landing event even factoring in as a catalyst yet. To put it another way, we seem to have reached the natural productive limit of our current economic policy path. We have, it appears, finally passed the Henry Hazlitt benchmark when “Today is already the tomorrow which the bad economist yesterday urged us to ignore.” Ominously, unless we mend the principles of our policy and deviate from the present approach of unsustainable economic manipulation, our NNNS condition will only worsen.
As Dr. Hunt explains, on one hand, “Fiscal policy has tools for promoting saving and investment that could be useful over time, but the subject is not even under consideration and options are contentious and unlikely to be enacted.” On the other (monetary policy) hand, “The Federal Reserve has great flexibility to act but its tools are counterproductive for ending the saving constraint… Increasing money supply growth does not provide additional tangible assets for growing the capital stock but it would accelerate inflation, rendering most households less able to save, enlarging NNNS and further boosting the likelihood of a lower standard of living.”
Folks, pick your metaphor. Perhaps it’s rapidly accelerating the wrong way down a one-way street, or maybe we’re futilely pushing massive boulders uphill. From a policy perspective, I’ll say we’re now the snake eating its tail.
We’re not facing reality; we’re running full steam away from it. We’re busy trying to construct a false and unsustainable alternate economic reality because, in all our wisdom, we surmise it’ll be more immediately palatable. In so doing, however, we have in fact dramatically increased the size and scope of the real challenges we must soon face. We’ve used unsustainable policy to build an unsustainable financial bubble right where the construction of a hopeful road to long-term prosperity and economic health would have served so much better.
Meanwhile, as John Hussman says, we’ve built this bubble on the shaky sand-laden foundation of risk—risk that “quietly extends across the whole system as a ‘skeleton of instability.'” At this point, it’s merely a thin facade of confidence holding this bubble together. But it’s a sort of cynical confidence. It’s confidence that policymakers will maintain their ultimately unsustainable course and keep this bubble inflated a little longer yet. As long as the day of reckoning is perceived as distant, after all, market participants can profitably pick pennies off Wall Street before the steamroller arrives.
But recall, when bubbles break, they tend to break hard, unexpectedly, and nastily. When that steamroller does arrive, penny picking turns blood sport in a hurry. Any material loss of confidence now comes with the risk of putting a pin to the bubble, exposing the hollow reality underlying the facade, and kicking the legs out from under the skeleton of instability.
As Dr. Hunt suggests, inflation remains the soft underbelly of our unsustainable policy confidence game. With the attempt of government policymakers to manipulate economic variables (variables naturally in flux) into a contrived Goldilocks arrangement, inflation is the most likely uncooperative release valve for broken and untenable policy. Again, in Dr. Hunt’s words, the Fed “has great flexibility to act but its tools are counterproductive for ending the savings constraint.” Instead, Fed action “would accelerate inflation, rendering most households less able to save, enlarging NNNS and further boosting the likelihood of a lower standard of living.”
At this point, despite highly touted headline reports advertising economic boom time in the go-go 2020’s, the details in both the latest government budget data and GDP report sing the same alarmingly consistent, unsustainable tune—we have to increasingly spend more of what we don’t have to return ever less of what we actually want. Unsustainability is action that can’t be both habitual and enduring. It’s our present policy course. At a minimum, a doom-loop toward less aggregate savings and a resulting lower standard of living is the expected result.
When this author spots a company growing debt faster than earnings, and paying interest on debt (interest expenses that exceed free-cash-flow) by borrowing even more debt, a “zombie” business model is identified. In such instances, be sure, the company’s stock is avoided like the plague. Similarly, when a zombie business model is implemented on the government scale, HAI prefers to invest in gold and hard assets with real value rather than in the rapidly depreciating value of that government’s currency, debt obligations, and/or derivatives thereof.
Now, economist John Meynard Keynes waxed poetic about the “paradox of thrift.” He argued that while the concept of thrift was a good standard for an individual or individual company, it wasn’t the standard for the economy as a whole, or a good model for government economic policy. While acknowledging some of Keynes’ argument, HAI must ultimately agree to disagree and contend that we’re currently past that point by a country mile. Rather, HAI wholeheartedly supports Lacy Hunt’s conclusion that the paradox of thrift “does not apply during periods of NNNS.”
As Dr. Hunt explains, “Without the thrift essential for national savings, resources are insufficient to cover depreciation, and the capital stock, critical for the standard of living, shrinks.” Again, when the music stops, the bubble pops, and the curtain drops on the great and powerful wizards of confidence—a new investment paradigm awaits. In that new paradigm, expect market leadership regime change to rapidly ensue. While many short-term trades can be risked amid the present dynamics of the current market set-up, from a longer-term investment perspective, HAI wants to own core holdings in gold, related precious metal assets, and hard assets broadly. It’s this cohort of regime change assets that’s most likely to avoid the steamroller and represent new market leadership amid the new rules of the new paradigm in the new market cycle that lies ahead.
Weekly performance: The S&P 500 gained 1.06%. Gold was down 0.59%, silver was up 0.71%, platinum gained 1.58%, and palladium increased by 1.34%. The HUI gold miners index was flat. The IFRA iShares US Infrastructure ETF gained 1.54%. Energy commodities were again volatile and mixed on the week. WTI crude oil gained 6.50%, while natural gas continued lower, down another 3.42%. The CRB Commodity Index was up 3.09%, and copper added 1.69%. The Dow Jones US Specialty Real Estate Investment Trust Index was down 0.50%. The Vanguard Utilities ETF was up 0.42%. The dollar index was up 0.16% to close the week at 103.23. The yield on the 10-yr U.S. Treasury held steady to end the week at 4.15%.
Have a wonderful weekend!
Investment Strategist & Co-Portfolio Manager