Recession Risks - Two Big Ones

Slowdown Increases Recession Risk

During economic slowdowns there are increased Recession Risks. Because the last recession nearly collapsed the financial system, investors think there needs to be a massive catalyst to end the business cycle. The 2008 recession was a once in a generation event in my opinion. 

That doesn’t mean I’m predicting another crisis in 20 years. It can come sooner or later than that. On average, that type of recession should affect the economy about once every 30 years.

That being said, it might never occur again because there won’t be another housing bubble because of the new mortgage lending laws. Economic panics in the 1800s which we now see as depressions occurred often. Great Depression of the 1930s was simply the last of these severe recessions. 

U.S. economy has become more diversified and monetary policy has improved since then. 2008 recession wasn’t nearly as bad as those depressions. But the economy came very close to a total collapse. That explains why the S&P 500 fell over 50%.

Because that type of financial crisis is rare, don’t try to look for one now

Recession Risks - There doesn’t necessarily need to be a massive bubble that topples the whole economy for there to be a recession. Usually, recessions occur when there is a slowdown combined with a moderate sized negative catalyst. Since the economy is in a slowdown, we must look out for potential catalysts. 

The period with increased recession risk might end early next year, but in the meantime the risk is high. Two of the most obvious risks that could cause a recession are the trade war with China and the weakness in the auto industry.

On the trade war, President Trump stated on Monday, America is “not ready” to make a deal with China, but he does expect one in the future. He also stated tariffs on Chinese imports could go up “substantially.” Essentially, the trade war situation is status quo. 

Investors expect there to be little negotiations in the next 3 weeks. Then we expect negotiations to heat up as the G20 summit approaches. It is from June 28th to June 29th in Japan. A meeting between President Xi and Trump will likely occur at that summit. 

Everyone will say how productive it was and then a few weeks later we will know if anything positive actually occurred.

Trade War Job Cuts & Brief Review Of Costco Online

Recession Risks - Job cut announcements have increased in 2019. April reading was more encouraging than the readings in Q1, but year to date layoff announcements are up from last year. 

As you can see from the chart below, tariff impacted sectors like autos, industrial goods, and retail is seeing the biggest increase in job cuts since at least 2011. It’s not a huge surprise we’re seeing these cuts since the retail and auto sectors have been weak. Retailers who haven’t adapted to the new online landscape have gone bankrupt or are closing stores quickly.

One rare example of a retailer that hasn’t adapted to this new landscape, but has been successful is Costco. The company has a weak website and app and it shows in the user surveys. 

As of March 2019, only 3% of Costco members shop on the firm’s website once per week. 41% said they shop on the website infrequently. 41% stated they either tried using the website once or have never used the website.

If Costco invests in its online presence, it could grow sales quickly like what Target is doing. Specifically, only 10% of members stated they tried Costco’s fresh grocery delivery options. Since this is expected to become a more popular way of getting groceries, Costco must get its shoppers interested in its platform. Or they might go elsewhere. 

Therefore, you can view Costco’s position as a big red flag or an opportunity for it to grow. That depends on your assessment of their plan and their ability to execute on it.

Auto Sector Job Cuts

Recession Risks -The auto industry is in a tough position. Sales are dwindling and auto loan delinquency rates are increasing. It’s interesting to see such weakness in this industry considering the relatively strong labor market. Imagine how weak demand would be if jobless claims and the unemployment rate spiked. 

The housing market would be as weak as the auto market if interest rates didn’t drop. A big decline in 30 year fixed mortgage rates have been a saving grace for the housing market. Even so, housing price growth has fallen quickly. The decline in rates lowers the likelihood there will be an outright yearly decline in prices.

As you can see in the chart below, the 6 months moving average in announced job cuts in the auto industry has exploded. This burst explains the increase in the chart above. 

It’s good to have a moving average because monthly readings can be very volatile. It’s not surprising to see such a spike in layoffs because demand has been weak. I have been expecting auto sales to be weak in 2019 since the start of the year.

The main reason auto industry weakness is a potential recession catalyst is because it has been the 2nd biggest big driver of consumer debt this cycle. In the Q1 NY Fed quarterly debt report, auto debt increased to $1.28 trillion. It was $810 billion in Q1 2008. In 11 years it increased by 58%. 

90-day delinquency rate on auto loans is up to 4.7%. If it is increasing while there is a low unemployment rate, imagine how bad it will get when people lose their jobs outside of these few weak industries.

Recession Risks - Conclusion

Even though it doesn’t seem like the economy suddenly faces increased recession risks. This is based on the stock market’s lack of a 5% correction this year. Latest economic data puts investors on red alert for anything that can topple this weak economy. 

Markit flash PMI and durable goods orders report showed sharp sequential weakness. As you can tell, this recent string of bad data has made me more negative on the economy than I was earlier in the year. Two potential catalysts of a recession are the trade war and auto industry weakness.

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Don Kaufman: Trade small and Live to trade another day at Theotrade.