By Richard Morey
November 2023
Why No Recession Yet?
Throughout history, every time the Fed has raised interest rates, and short-term rates were higher than long-term rates, i.e. an inverted yield curve, the economy has landed in recession. The amount of time between the first rate hike and the ensuing recession varied widely within a range of 1 to 3 years (with one longer outlier and one shorter).
The Fed started raising rates last March – 1 year and 8 months ago. Therefore, interest rates wouldn’t necessarily be expected to have put us into a recession – yet. That being said, the shortest time between rate hikes and recession was in 1981-2. Since this was the last time inflation was the cause of the problem, many analysts expected us to be in recession by now. Why hasn’t this yet occurred? There are two main reasons:
Credit Card Debt
The most obvious reason involves consumer spending. The government stimulus money individuals and businesses received during the pandemic lasted longer than anyone anticipated – but it’s all gone now.
Looking at the third quarter GDP growth numbers is quite revealing. Last quarter the economy was held up – entirely – by the collapse of the personal savings rate. In one quarter the total savings rate fell from 5.3% down to 3.4% – the largest, fastest drop in more than decade.
This is the extra money consumers tapped to keep spending, and the US economy, expanding. With none of the extra pandemic money left, consumers went on a credit-card purchasing binge to maintain their standard of living.
However, credit card spending has obvious limits – a fact that becomes clear when the interest rate on the balances is now the highest on record. The question is not whether this will continue indefinitely but whether it will last through the holiday shopping season.
With little savings left and credit cards getting maxed out, there are exactly two ways consumers can keep consuming:
- Increase their incomes. Unfortunately, inflation-adjusted incomes have continued to go down, not up. The chart below from the St. Louis Fed shows income declining each of the last five months.
Real Disposable Personal Income: Per Capita
[wptb id=17183]
But what about all the wage increases we’ve seen in the news? Yes, millions of workers have indeed seen their salaries increase, just not enough to offset the total rise in prices. If earned income doesn’t pick up, consumers will have their new, larger credit card balances to pay off and less monthly income to accomplish this.
- The only other way to keep the spending going would be to have the government transfer more money to everyone. As we saw during the pandemic, if the government sends a few trillion dollars to everyone, they will indeed keep spending more money.
Of the two ways consumer spending can continue to bolster the economy, as long as the House of Representatives is controlled by the Republicans, the chances of another huge consumer bailout with cash is exactly zero. This leaves a big upswing in consumer wages as the only way to keep the economy from contracting. While not impossible, we can already see wage pressure decreasing in many industries.
The Presidential Election Cycle
For many years the occasional client has pointed to the election cycle 
as perhaps a way to understand the economy and markets. Since I’ve never heard a rational explanation as to how and why this would work, I have always ignored this topic.
However, the numbers really are striking. Since the Great Depression, not a single recession has begun during the (first 9 months) of the 3rd year of a presidential election cycle. I saw an analysis showing the month every recession began. Every month during every election cycle has seen 1-5 recessions begin. Then you look at the 3rd year and see 9 straight months with no entries.
Again, the analyst who wrote the report also couldn’t explain why this might be the case – no idea at all. Yet there is enough consistent data to think perhaps this factor meant we simply weren’t going to enter a recession from January through September of this year. Odd but possibly true.
Since the Economy grew 4.9% in the 3rd Quarter, Surely a Recession is Not on Horizon?
First, it’s highly unlike the economy grew 4.9% from July-September this year. Keep in mind that the 4.9% increase in GDP measures all the goods and services bought and sold in a quarter. The flip side of this equation is called Gross Domestic Income. They measure the exact same thing, and as we saw above, incomes fell each month last quarter.
However, for this discussion let’s assume the economy did grow 4.9% last quarter. This must mean recession is nowhere on the horizon, or does it? Let’s look at the facts.
In the third quarter of 1981 GDP rose the exact same 4.9%. This turned out to be the quarter we actually entered recession! This was the last time we had serious inflation, so history may be repeating itself.
In the first quarter of 1960 we had a blowout GDP number of 9.3%. The next quarter we were in recession. I suspect nobody thought it was possible to have such a huge growth number followed immediately by contraction – until it happened.
There are seven instances in modern times when we got a big GDP number shortly before entering recession. (I wonder if income was already falling in the other cases – harder to know due to GDP data being reported more often than GDI.) Why does this occur? I’ve never found an answer to that question, though if you look at the assumptions embedded in the GDP calculations you can see they tend to be invalid whenever the economy turns down. Or it may be due to politics, with each administration encouraging the thousands of statisticians who calculate GDP to err on the side of growth until the reality of a recession becomes impossible to ignore.
What Does All This Mean for Investors?
If you study the stock market for many years, it almost appears as if it is designed to extract the biggest losses possible for investors. The financial media, government economic officials, and even the data itself always assures everyone we’ll have not a recession but a “soft landing.” All year the media has been hyping the idea we’re having just such a soft landing. The problem is, every recession begins with the prevailing assumption we’re having not a contraction but simply a moderation in growth.
As a result, stock investors never seriously consider the risk. Much of the problem is simply human nature. When we meet new investors these days we find that even retired people tend to be all-in on stocks, with most having 85-100% allocated to stocks and stock funds. They have a distinct tendency to look at their balance at the most recent high point, which in this case is January of last year. Even those who are aware of the risks markets face can’t bring themselves to protect their portfolios until they get back to where they were at the top. Of course, if stocks were to fully recover they definitely wouldn’t consider trimming their stock exposure due to the recent gains. It’s much like a catch-22 in which they can’t sell when stocks have gone down and they can’t sell when they’ve gone up.
This time around is more difficult than ever due to the fact it’s been such a very long time since we had a real, bona fide bear market. Since 2009, every downturn in stocks has seen them go straight back up in short order. Investors have therefore learned one lesson: There is no real risk in stock investing just so you never sell.
Those with the highest account balances have learned an even more valuable lesson, which is that you should simply put most of your money in the 7 stocks which have led to nearly every penny of stock market gains this year: Alphabet, (Google) Amazon, Apple, Meta (Facebook), Microsoft, Nvidia & Tesla.
This is precisely the lesson investors had learned so well by 1999. Back then we had a similar lineup of big tech companies. These were great companies which were highly profitable, so why worry about their prices? In retrospect, perhaps the fact they fell over 80% the next two years should lead thoughtful investors to reexamine their portfolios. Seatbelts were invented for a reason. There is no reason not to have a secure hedging strategy to protect your investments.