FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
September 26, 2023

IN THIS ISSUE:

1. Why The Bearish Case Is Wrong For The U.S. Economy & Equities

2. Cascading Crises' Could Tip The Balance of Slowing Global Economy

3. Fed Left Interest Rates Unchanged But Warned of More Hikes

Overview – Why The Bearish Case Is Wrong For U.S. Economy & Equities

As we head into the 4Q of 2023, it is helpful to look back at the forecasts and predictions I’ve made this year and make an assessment. In doing so, I realize that my best prediction for 2023 was not to jump on the bearish bandwagon.

If you recall, we came into 2023 with the vast majority of forecasters predicting a recession this year as the most likely scenario. As regular readers know, I never agreed a recession was the most likely case for the economy this year. In fact, I argued that a recession was NOT the most likely scenario. I expected the economy to expand this year, albeit at a slower rate of growth.

And that is exactly what we’ve seen. The US economy as measured by Gross Domestic Product grew at an annual rate of just over 2% in the first half of this year – not great but still a solid performance. As I pointed out often, there were few signs that a recession would unfold in the last half of the year.

In fact, not only did a recession not happen, the economy began to strengthen in the 3Q, with the Commerce Department revising its economic forecasts by ruling out a recession or pushing the timeframe for the expected slowdown into 2024. That is where we stand today.

The Commerce Department reported that GDP growth had accelerated to near 6% early in the 3Q. Many of us in the forecasting world doubted that the economy could be growing this fast, and many of us predicted this trend was unsustainable and that growth would ease – and it has.

The latest GDP report showed the economy climbing at a 4.9% annual rate in the 3Q, and most forecasters, including yours truly, expect the deceleration to continue but the economy should  to remain in positive territory in the months ahead.

But as always, there is still a contingent of forecasters who are bearish on the economy and continue to predict a recession later this year or early next year. While I continue to disagree with these bearish forecasts, I thought it might be helpful to point out the basis on which the negative crowd makes their case.

I’ll list their main arguments below and explain why I think they are likely to continue to be wrong. As always, you can draw your own conclusions. Here we go.

The Bearish Case For The U.S. Economy & Equities

As noted above, most forecasters have backed off their predictions for a recession starting in the 4Q, but most warn that some red flags are still out there we should continue to keep in mind. Here are the most common red flags cited by the bearish crowd.

An “Uncertain Outlook” From Leading Indicators. Many mainstay economic indicators measure the past. Yet the so-called leading economic indicators reflect what likely lies ahead. The Conference Board's U.S. Leading Economic Index for July marked its 16th consecutive drop and its longest losing streak since the run-up to the Great Recession in 2007 and 2008.

This Index is based on 10 components, ranging from stock prices and interest rates to unemployment claims and consumer expectations for business conditions. In its latest report, the Conference Board concludes:

"The leading index continues to suggest that economic activity is likely to decelerate and descend into mild contraction in the months ahead."

So, the Commerce Department continues to believe at least a mild recession lies ahead.

Consumer Confidence Is Just a Hair Above Recessionary Levels. The Conference Board’s latest Consumer Confidence Index came in at 80.2 in August, hovering just above 80, the level that often signals the US economy is headed for a recession in the coming year.

It is also a leading indicator used to predict consumer spending, which drives more than two-thirds of US economic activity.

Consumers Are Foregoing Big-Ticket purchases. Retailers report that their customers have shifted their purchasing habits, spending less on furniture and other big-ticket items in favor of necessities. They have also been trading down on grocery items, ditching pricier cuts of beef and buying chicken.

“We saw some switch even to some canned products, like canned chicken and canned tuna and things like that,” Costco’s Chief Financial Officer Richard Galanti told analysts on a recent conference call.

Consumer spending has remained one of the bright spots in the economy, but most forecasters expect consumer spending to slow by as early as next year. That remains to be seen, of course, but I see few signs that US consumers are going to significantly cut back on spending just ahead.

Credit Cards Are Maxed Out. US consumers ran up their credit card debt past the $1 trillion mark for the first time last month, according to a report on household debt from the Federal Reserve Bank of New York. Total household debt, which includes home and auto loans, has eclipsed $17 trillion for the first time ever.

Fortunately, the Federal Reserve Bank of St. Louis reports that credit card delinquencies are still low compared to periods such as the Great Financial Crisis. Next,

Banks Are Increasingly Reluctant To Lend. The latest Senior Loan Officer Opinion Survey by the Federal Reserve reports tightening credit conditions across the board, from business loans to home mortgages and consumer credit.

When banks pull back on lending, businesses curb their investments and consumers cut spending, and this trend is expected to continue for at least the rest of the year.

“Regarding banks' outlook for the second half of 2023, banks reported expecting to further tighten standards on all loan categories,” the Fed survey concluded. “Banks most frequently cited a less favorable or more uncertain economic outlook and expected deterioration in collateral values and the credit quality of loans as reasons for expecting to tighten lending standards further.”

Corporate Bonds Are Maturing and Refinancing Them Will Be Costly. Goldman Sachs estimates that $1.8 trillion in corporate debt is coming due over the next two years and it will have to be refinanced at higher interest rates. The expense will eat up more corporate resources, possibly leading to slower growth and investment.

Recessions occur as debt levels peak and borrowers begin to default. Moody’s has already reported a surge in corporate defaults this year. In the first half of the year, it counted 55, that’s 53% more than the 36 that defaulted in all of 2022.

Manufacturing Remains in a Prolonged Post-Pandemic Slump. Manufacturing has been in decline for 10 consecutive months, as measured by the ISM Manufacturing Purchasing Managers Index. Respondents to the ISM survey reported weaker customer demand because of higher prices and interest rates.

"Orders are in fact falling faster than factories are cutting output, suggesting firms will need to continue scaling back their production volumes into the near future,” writes Chris Williamson, chief business economist at S&P Global Market Intelligence.  “An increasing sense of gloom about the near-term outlook has meanwhile hit hiring and led to a further major pull-back in purchasing activity.”

'Cascading Crises' Could Tip The Balance of a Slowing Global Economy.

China, a growth engine for the past 40 years, is still struggling to recover from the pandemic. As a result, global economic growth has fallen below China’s long-term average, and the ailing world could pull the US economy down with it.

Like a plane crash, every economic disaster stems from a confluence of mishaps. Along these lines, G20 nations put out a dire warning at the conclusion of their meeting:

“Cascading crises have posed challenges to long-term growth. With notable tightening in global financial conditions, which could worsen debt vulnerabilities, persistent inflation and geoeconomic tensions, the balance of risks remains tilted to the downside.”

The Yield Curve, a Classic Recessionary Signal, is Still Inverted. Investors should be paid more for taking a long-term risk than they should for a short-term risk. That’s why the yield on a 10-year Treasury is supposed to pay a higher yield than a 2-year Treasury.

When this is not the case, it’s called an “inverted yield curve,” and it has long been considered a sign that a recession is due within the next 12-18 months.

The yield curve for 10-year and the 2-year Treasury has been inverted since July 2022. It’s been inverted for so long that many observers have given up on its reliability — though it still hasn’t been 18 months since it first inverted.

Inflation is Sticky, and The Fed Isn’t Done. The soft-landing scenario that is now so widely embraced is based on observations that inflation has dropped precipitously as the economy continues to grow at a healthy pace, and the labor market is still holding strong with the unemployment rate at 3.8%, near a 50-year low.

The Fed, which has raised interest rates 11 times since March 2022 to curb inflation, can now take a bow. The Consumer Price Index, which measures inflation, has come down from a peak of over 9% in June 2022 to 3.2% on its last reading in July.

Fed Left Interest Rates Unchanged But Warned of More Hikes

Meanwhile, the Fed policy committee met on September 19-20 to decide on interest rates and elected to keep them unchanged at 5.25-5.50%. It is also holding fast to its 2% target for inflation and will keep rates higher for longer, or possibly even raise them further to meet that goal.

In conclusion, the points noted above represent the negative view of the economy and a recession just ahead. Let me remind you again that I don’t agree this position is the most likely scenario just ahead. But I thought you might find it helpful to know where the bears are coming from. I’ll leave it there for today.

Very best regards,

Gary D. Halbert

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