Economic Health

Current Market Conditions

*Background*

The past 2.5 years in the housing market, as everyone knows, has been tumultuous. Unprecedented price increases were due to high demand from low interest rates in a time when people had more cash in their pocket. From government stimulus checks, less spending on travel and transportation, and before record 40-year high inflation, those looking to purchase a home were in a position to, in many cases, offer 20-30% above asking price and forego contingencies to secure their purchase over the 15 others who submitted offers. Those times are long gone.

In order to curb the record high inflation, the Federal reserve began quantitative tightening and increasing the federal funds rate which tells the banks they need to keep a larger amount of cash on hand, lowering the quantity of money available to lend and in turn, increasing interest rates. The main goal is to reduce the amount of money in circulation to contain inflationary pressures. In a time like the pandemic, where the economy was ordered to shut down and there was record government spending and monies flooding the world economies, this is no small task.

Is it working?

Since March 17th, 2022, the Federal Reserve has increased rates four separate time by a total of 225 basis points, bringing the federal funds rate from close to zero up to 2.5%. Since this has began, the housing market, along with almost everything else in the economy, has undergone an economic slowdown. No more are you seeing multiple offers and a property being sold over the weekend. Real Estate agents are adjusting prices lower across the board and average time on market has increased 5-fold in some areas of Southern California.

With this in mind, the Federal Reserve is successfully (although slowly) curbing inflationary pressures. We saw this with the most recent inflation data released for the month of July 2022 coming in at 8.5%, down from 9.1%. The 8.5% inflation we saw in July is still at a 40-year high, but it is moving in the right direction. This was the first drop we saw in the inflation reading since August 2021 where inflation went from 5.4% to 5.3% and it was the biggest drop in inflation since April 2020 where it went from 1.5% in March to 0.3% in April.

The Fed’s job is not easy, especially in unprecedented times we have been living through. You may have heard the “Fed is attempting a soft landing” with the techniques being deployed to curb inflation. A soft landing would be a situation where we don’t end up in a recession, or worse, a global depression, and we reach the Federal Open Market Comity (FOMC)’s goal inflation measure of around 2% with a minimal amount of economic pain as possible. If we take a broader look at economic health indicators in the US, it is becoming clear that we are far from a soft landing.

Personal Savings Rate

One such indicator that can give a general look at the health of the consumer in our economy is the Personal Savings Rate. Provided by the St. Louis Fed, they explain it as “Personal saving is equal to personal income less personal outlays and personal taxes; it may generally be viewed as the portion of personal income that is used either to provide funds to capital markets or to invest in real assets such as residences.” In other words, it’s the rainy day fund or fun money, the liquid assets you have available to purchase any number of things you may want but don’t need, including real estate.

The Personal Saving Rate measure skyrocketed during the pandemic to the highest point on record (by a factor of almost 3) in April of 2020 to 33.8%. This makes sense because April 2020 marked the first stimulus payment and people did not have the option to go out and travel or spend money on entertainment or shopping for things they wanted but didn’t need. Each time the government issued a new stimulus payment, the PSR reading did the same thing but quickly declined thereafter.

Fast forward to now, the Personal Savings Rate sits at its lowest point - 5%, since August of 2009 where it was 4.5%. So, broadly speaking, the consumer is at a point where there isn’t much wiggle room outside of necessary spending, largely due to inflation on food and energy, to go out and buy a second property.

The psychological sentiment of the consumer during difficult times in the economy is just as, maybe even more, impactful to the health of the economy. Economics is a social science just as much as it is a numbers game, it analyzes why consumers do what they do in different trends and economic policy reflects this. One thing to remember is that the consumer is the economy- without you, it wouldn’t exist. Everything that exists in the economy is because there is someone out there that is interested in purchasing it. The free market weeds out the good from the bad.

Consumer Sentiment

This leads to the next indicator that looks at how the consumer feels about the overall health of the economy. Consumer Sentiment, also provided by the Federal Reserve of St. Louis and the University of Michigan, suffered one of its worst near-vertical drops in the history of its recording from February 2020 through April 2020 where it went from a reading of 101 down to 71.8. Once again, thinking back to this time, the consumer was unsure of the impacts that the global economic shutdown was going to have. As the government stepped in and handed out stimulus and more information came out on the severity of virus, the Consumer Sentiment indicator began climbing back up to its high of 88.3 in April of 2021. The pandemic seemed to be over to many, businesses were opening back up, there was light at the end of the tunnel.

April 2021’s inflation reading was the first big “uh-oh” in the economic world coming in at 4.2% which was a rate not seen since the middle of the great recession in September of 2008 at 4.9%. To put the importance of inflation rate in perspective on the affect of consumer sentiment, if there’s an inflation rate like our latest of 8.5%, this means that if you didn’t receive an increase in your wages of 8.5% from last month, you are in fact losing 8.5% more of your income this month because your’e paying the difference at the grocery store and other purchases. Even if the consumer isn’t aware of the increased prices they’re paying, their bank account will notice, and it will eventually hit them in the face and force them to make a change in their spending habits.

Consumer Sentiment, or how people feel about the current state of the economy, is currently sitting at the second lowest point on record in July 2022, only behind June of 2022. Currently at 51.5, a full 20 points lower than the April 2020 reading at the beginning of the pandemic. Your average consumer is more uncertain about the future of the economy than during the great recession, 9/11, and the three recessions before that.

Personal Consumption Expenditure

An argument can be made that consumer spending or Personal Consumption Expenditure (PCE) is a more accurate indicator than consumer sentiment. In determining the health of the economy, you will hear many economists displaying the current consumer spending measures in support of showing that there is not a large downturn in economic health and that we are not currently in a recession. After all, if the consumers are the economy, and the consumers are spending more than they did last month, that must mean economic strength; the consumer is in good shape.

The fact is, PCE data can be misleading when the economy is in a high inflationary environment; of course people are spending more when your food costs increase by 10% and energy costs which include gas for your car increase nearly 20%. If an economist presents PCE data alone to signify a strong consumer environment while leaving out consumer sentiment, you are being mislead.

All recessions are different, this is true. If you look back to previous recessions, PCE normally drops at some point during it. During the Great Recession which began in December of 2007, PCE kept climbing for another 7 months until it began dropping in July of 2008. During the short recession from March to the end of April 2020, PCE dropped immediately before because of different economic factors. Currently, consumer spending is seeing a slower rate of increase compared to the last months, appearing to be peaking within the next month - around release of August data in September 2022.

We entered a technical recession at the end of last quarter, July 2022, when we hit 2 consecutive quarters of negative economic growth, or GDP growth rate. Whether the National Bureau of Economic Research’s Business Cycle Dating Committee, who the government has given the authority to declare a recession, declares a recession or not, it is undeniable that the consumer is already facing, or preparing to face economic hardship at this point. The Fed’s goal to provide a soft landing in their voyage of quantitative tightening and federal funds rate increases is crumbling and economic hardship is right around the corner.

We see this in many areas including a recent PwC survey showing that 50% of US employers expect layoffs now or in the near future. Another couple examples of the coming hardships is large retailers attempting to dump inventories through off-season sales, home prices dropping in the SoCal market up to 20% with very few buyers. The Federal Reserve Chair, Jerome Powell, himself, warned “pain” is around the corner and that they plan to still take a very aggressive monetary tightening approach - continuing to raise rates.