As we enter the second half of 2023, the economy continues chugging along.
GDP growth for Q2 is currently estimated at 2.3% and inflation continues dropping, with the latest June headline CPI just in at 3.0%
Have those warning of recession been wrong?
Or will the lag effect result in a bumpier ride for the remainder of the year.
To find out, we welcome economic cycles analyst Eric Basmajian, founder of EPBResearch, to the program.
Eric Basmajian 0:00
I would certainly expect the broad markets to make new lows. So that would be through the October lows if the economy does go into recession, as I expect, and you know, it’s really tough to say in terms of magnitude, but I’ll throw out a somewhat average recessionary decline to let’s say, something in the vicinity of 30% peak to trough.
Adam Taggart 0:29
Welcome to Wealthion, and Wealthion founder Adam Taggart, as we enter the second half of 2023, the economy continues chugging along. GDP growth for q2 is currently estimated at 2.3%. And inflation continues dropping with the latest June headline CPI just in at 3.0%. So have those warning of recession been wrong? Or will the lag effect result in a bumpier ride for the remainder of the year? To find out, we welcome economic cycles analyst Eric Basmajian, founder of EPB research to the program. Eric, thanks so much for joining us today.
Eric Basmajian 1:08
Hey, Adam, happy to be on. Thanks.
Adam Taggart 1:11
Hey, pleasure to have you on your first time on the channel. We’ve been trying to make this happen for a while glad we were finally able to do so. I’ve had a number of people in the Wealthion audience pinging me week after week to say, Hey, you gotta get Eric on the program. I hope they’re happy now that we finally made this happen. Lots of questions for you based upon some of your recent research. Eric, just to kick things off, though, if we can start off at a high level, what’s your current assessment of the global economy and financial markets?
Eric Basmajian 1:38
Okay, loaded question up front. I think if it’s okay, the best way for me to answer that question, Mr. kind of loop in what it is that I do and how I would even go about answering that question. So as you mentioned, I’m focused on business cycles. And business cycles are really the transition from periods of expansion in aggregate economic activity to periods of contraction, and aggregate economic activity is defined by all of the major variables that we all talk about all the time, your non farm payrolls, your retail sales, your wages, and things like that. So we’re tracking the transition from periods of expansion to contraction in aggregate economic activity. And Adam, you probably know, and most of the viewers know, that sine wave that most people draw to represent the business cycle. And that’s a good representation, because it shows that periods of expansion are followed by periods of contraction. But what I do that’s a little bit different is I focus, very specifically on the sequence of the business cycle. There are certain things that happen first, second, third and fourth, every single time, whether you’re an inflationary period, or a deflationary period. And that sequence is what gives the business cycle its rhythm. And I brought a couple of charts just to kind of illustrate at a very high level what I’m talking about. So what you can see in this chart is that instead of just one sine wave that represents the aggregate economy, I like to break the economy into three or four sine waves. And you can break this into five or six, or seven, but I find three or four tends to be most effective. And essentially, what we’re trying to do is when economic data comes in, we’re trying to separate it into is this a data point that’s going to be moving first, second, or third. And by following that progression, we can get a better sense of what’s going to happen to the aggregate economy. Now, in this chart, the peaks and the troughs are all drawn with sort of a uniform lead and lag time. That’s not the way that it happens. In reality, this is, of course, just an illustration. What remains the same from cycle to cycle is the sequence. But what’s different from cycle to cycle is the leads and lags between the first second third, and if I were to draw a fourth cycle here, so that’s the framing of how I go about making these decisions. And just for representation, I brought three composite indicators that will help illustrate what I tried to show in the first chart. So I brought I brought three composite indicators that help drive home that illustration that I was trying to present with our three different sine waves. So we have our leading economy, which is that first sine wave, we have our cyclical economy, which is mostly comprised of your construction and manufacturing. And then we have our aggregate economy, which is really what defines recessionary periods. The big stuff we always hear about your Non Farm payrolls. And if I was to have a fourth chart here, that would be our non cyclical or our lagging economy. So taking the progression here we can have an informed opinion of the current state of the global or US economy. And what we see is that the leading economy is deeply recessionary. leading indicators are contracting and contracting at rates that are only seen during recessionary periods. Now, our second two sine waves are cyclical economy and our aggregate economy are grinding at very low 1% growth rates. So that gives the setup that the economy is in an imminent recessionary stage because our leading economy is contracting. And our next two sine waves, the ones that really define the recession, are grinding at sub trend levels of growth very close to contractionary periods. And if the sequence remains the same, the leading economy is telling us the downward momentum. In the next two economies, the cyclical, and the aggregate will continue moving down, and there’s just not much buffer room before they fall below zero. Now, frustratingly, this was the exact same setup that we had in q4. In q4, if you look at maybe October of 22, in this chart, you had negative leading indicators, and you had about a one and a half to 1% growth rate in your cyclical and aggregate economies. So the assessment that I would give is that the economy remains in this imminent recessionary stage. It’s been in the same stage since q4 of last year. And being in an imminent recessionary stage for a couple of quarters is not entirely uncommon. But we do remain in the same position and the asset markets, mainly the stock market, let’s say has been oscillating around this imminent recessionary narrative, pricing it in pricing it out. And as we speak today, optimistically pricing out the recession, but the sequence and the constellation of indicators that I use to make that determination would suggest that we are still very much in the same imminent recessionary stage, despite the fact that it’s been grinding along for a couple of months here.
Adam Taggart 7:22
super fascinating before you hop off this chart, Eric, while the cyclical economy and aggregate economy are not yet in negative readings, as you said, they’re sort of grinding along at these low pre recessionary levels. But I gotta imagine that the trajectory of their decline is important here, right? That if you look at the momentum, it is to the downside on those graphs.
Eric Basmajian 7:44
That’s exactly right. That’s a very good point. And that downward momentum is foreshadowed by the downward momentum in the earlier parts of the sequence. If I if I was to make a guess, I would have guessed that we would have already seen the negative growth rates specifically in the cyclical economy, we’re stretching this, you know, lead lag time a little bit longer than than average, it’s not outside the range, that would be incredibly abnormal. But it’s definitely longer than the average. But you’re exactly right, that the momentum is decelerating. And it’s likely to be in my view, just just a couple of months before they they ultimately turned negative. And I would also make the point that for there to be a recession, the aggregate index must go below zero. That index is what represents a recession, those indicators that are held within that aggregate economy index are exactly the indicators that the NBA er uses to define recessionary periods. So the aggregate economy index has to go negative for there to be a recession. But the recession often begins when it’s backdated a few months before it goes negative. So hypothetically, Adam, if at the end of the year, the aggregate economy index is reading negative 1%, it’s entirely possible that the Envy er goes and dates the start of the recession to let’s say, Now, even though it’s not negative, yet, it’s has to go negative for there to be a recession, but the recession start usually occurs when the index is is just outside of negative territory, because it’s that momentum that starts the recessionary process.
Adam Taggart 9:34
Okay, got it. Super interesting. And let’s pull the slide back up just for one second, if you can, Eric. So, as you mentioned, a lot of people have been kind of waiting for this recession for a long time. Some say it’s the most telegraphed recession we’ve ever had and therefore it won’t happen. I hear you correctly, you think it is going to happen in Acting might have already started. Now, we won’t find that out for a while. But I did hear you say, you do think that preponderance of the probabilities are that we will go into recession from here. Now, let’s go back to October of last year for a moment, like you said, you can really see the bounce there in the aggregate economy data, right. The question I’m going to ask is, so what, what’s responsible for that? What, what gave air back into the balloon to let the numbers go back up? I’m gonna presume maybe China’s opening helped. And we’ve had some people on this program recently who have been looking closely at liquidity, and they said sort of net global liquidity reversed from negative to positive, then Were those the factors Was it something else?
Eric Basmajian 10:44
Yeah, all good points. And these are sort of the variables that create these leads and lags being different from cycle to cycle. I’d also throw in we had a little bit of a crisis there in March. And what makes these cycles different every time is the response to a crisis like that can certainly determine the near term trajectory for some of these indicators had that crisis been handled differently, we perhaps could have seen negative growth rates already in the aggregate economy. So it does really depend when we’re talking about any given month or a couple of months on a lot of extraneous variables. But what gave the cycle its bounce, there was a couple of things that stand out to me in the data is, number one, almost all of the increase that we’ve seen happened in the January month, very specifically. And what happened in the January month, was that there was an 8% cost of living adjustment in most entitlement programs as a result of the 2022 inflation. So there was a large spike in income as a result of the cost of living adjustment for transfer payments in January, that spike in income helped propel a increase in some consumer spending, which caused a little bit of a bounce from the December readings that were quite low. A second thing that has contributed to the bounce is that we pretty much have I’ll say solved most of the supply chain problems, you don’t really hear a lot of people talk about things being difficult to get. The one industry that’s lagging behind is the auto sector, there remains some supply chain pressures with the chips and various auto parts. So we had an increase in auto production in the first couple of months of the year, which bolstered some of the manufacturing indicators. And that was really a result of of some alleviation of some of these really long lasting supply chain delays. So I would account the stability in the first quarter, mainly to a cost of living adjustment on entitlement programs, mainly Social Security, as well as a boost in manufacturing production that was mostly propelled through the lags of supply chains of the auto sector.
Adam Taggart 13:13
All right, got it. Interesting. So the 8% cost of living adjustment. I mean, that’s a form of fiscal stimulus here, right, where the government’s just giving more money directly to people. So just to have the question off at the past that some folks might ask, which is well, okay, so we kind of saved the economy, then, you know, why can’t they just do that, again, you know, later this year? Are there arguments against for why another stick save may not be as forthcoming?
Eric Basmajian 13:42
Yeah, so one of the things that that is important to keep track of is that the sequence is is always the same. And a lot of these things get baked into the cake, before they show up in aggregate economic statistics. So for example, the real drying up of new orders that we’ve seen in the manufacturing sector is going to filter through to a decline in production, even if the new orders start picking up today, because we have this gap of new orders that didn’t occur for the last 10 months. So we’re going to have this decline in production that’s going to have to filter through no matter what. I would also say that, over the last couple of months, there’s been several developments that have occurred that have reinforced the downward momentum that we’re seeing mainly in the banking sector. For example, we’re seeing a continuation of a contraction in deposits in the banking system, specifically what are called other deposits, which is the biggest line item. So a contraction in deposits is ongoing as a result of the Fed continuing to raise rates. And that has caused a official contraction in aggregate bank credit so far now. that contraction is happening mostly from securities, although the loan growth is starting to slow down. So even though the Fed and fiscal policy may have had a stick, save, that sticks save prevented the economy from maybe having an abrupt recession then, but it continued to reinforce some of the monetary tightening that’s going on in the banking sector. And that feeds through that leading economy variable, which is why it’s still pasted at cyclical lows in terms of its growth rate. Had this been a a cyclical stick, save, where we were going to avoid the recession for many, many quarters to come, we would have seen these leading variables start to pick up steam and move higher. The fact that they haven’t is more evident of the fact that it was a short term solution rather than a real cyclical change in direction.
Adam Taggart 15:51
Okay. Okay. helpful answer. I’m gonna ask you to put that chart up just one last time, if you don’t mind, of course. Just want to make these indicators real for folks. So when we look at the way for to come up here, okay, great. So when we look at the leading economy, this is based off the Conference Board leading index. Can you just give an example of one or two indicators of Yeah, economy?
Eric Basmajian 16:20
Yeah, so I think it’s good. And I’d love to take a second to just talk about the concept of each bucket. So more important than the actual indicators that are in each one is the concept of why the leading economy moves first, then the cyclical economy, then the aggregate, and then the lagging, so I’ll kind of rattle through all of them. And I’ll pretend like there’s a fourth one here, which would be our non cyclical or our lagging, so are leading economy components that would be in there would be things that move first. So changes in monetary policy or monetary aggregates, changes in interest rates, and then changes in soft commitments like new orders and building permits. And then there’s also the yield curve, which is a take on a monetary variable, because monetary stance impacts the slope of that yield curve. So within the whole leading economy bucket, you’re looking for things that respond almost immediately to changes in monetary policy. And you’re also looking for soft commitments that would lead actual activity. So you think of New Order commitments, building permit commitments, things like that. Monetary policy most directly impacts the cyclical economy, because its interest rate sensitive, and the cyclical economy is our residential construction, and manufacturing. Those two sectors of the economy are more interest rate sensitive than the rest of the economy, which is why they tend to respond next in line. So you can think of employment and output in the residential construction and manufacturing sectors. The aggregate economy is what the NBA er uses to define recessions. Those are our biggest, broadest measures of income, consumption, production and employment. So you can think of non farm payrolls, real personal income, real retail sales. We have real consumption. And we have, there’s actually two measures of employment in there as well. So there’s six total, but you’re looking at income consumption, production and employment. And then if we were to have a fourth category here of our non cyclical or our lagging components, that’s where you would contain all of your services consumption, your non residential construction, we see a lot of charts today, Adam of non residential construction spending, and people are posting these charts of these large hockey sticks in manufacturing construction spending, for example, saying that we’re going to avoid recession because of that. But when you move through it in the sequence here, you can quickly see that it’s really just a a very significant lagging economic indicator. So in concept just to go through it quickly, we have our changes in monetary variables and soft commitments. Then we have our levels of activity and employment in residential construction and manufacturing. Then we got the whole pie everything put together in the aggregate. And then we have our services, our non residential construction and our government type work in our lagging components. And that’s the progression that the cycle takes every time irrespective of whether it’s a inflationary or deflationary type recession.
Adam Taggart 19:51
Okay, and you might have mentioned this earlier, but if we did have a chart up here, of the lagging non cyclical part of the account Let me what sort of shape would it have.
Eric Basmajian 20:03
So I can probably best show that by showing another chart here where I do this analysis, but I do it for employment rather than the aggregate economy. So what this chart is showing here is we take the employment numbers that come in, and we break them into cyclical employment, or total and then are non cyclical. And what’s important about this chart is that the sequence is the same every time, red line, blue line, black line in terms of the order in which they move into contraction. You’ll notice though, that the black line, what a lot of people are focused on, which is your service as economy sometimes doesn’t even contract in recessionary periods, which kind of tells you that it’s not something that we should be focused on that specifically. And when we go down a little bit, let me see if I have the chart here with me, Adam. If we if we break down the components, on a more near term basis, what we can see is our private cyclical employment has started to move down very aggressively and is on the verge of contracting. And then our private, non cyclical, and then our government education and health care is what’s really holding the economy up. So we don’t really have a huge downturn in the lagging type indicators, your government education and health service, you’ve kind of normalized the trend on your private, non cyclical, and then the private, very cyclical is what’s really experiencing the bulk of the contraction now.
Adam Taggart 21:41
Okay, great. I do want to dive more deeply into this exact employment data in just a second. Real quick, though, when we when we talk about the these trajectories that you have, I don’t know if you want to go back to the original chart, but it’s showing you know, your your main cycles, they’re leading cyclical aggregate, one’s already in recession to look like you’re headed for it. We’ve been talking a lot in this channel recently have been asking a lot of the experts on this channel about their estimate for the impact coming impact of the lag effect of you know, all the hiking all the tightening that the central banks have been doing. Add on top of that the additional cooling effect on economic growth from the tightening lending standards that the banking industry has been enforcing. Do you expect those to quit additional gravity on these downward trajectories here is there’s a lot of people that are beginning to say, you know, you talked about the the folks that are looking at the spike in the lagging indicators and construction and whatnot and saying, Hey, like, it looks like we’re going to avoid recession, right? There’s a lot of people that are beginning to say, what lag effect, you know, it’s been a year and a half, we haven’t really seen much is that impact is the lag, which by definition means it’s going to take a while to show up. Is the lag going to materialize? And if so, is it going to be material?
Eric Basmajian 23:11
Yes. So let’s talk about Adam, the process of a recession. So in our aggregate, economic indicators, we have income consumption, production and employment. And the reason that those are important is because they move together in a cycle. That’s why the economy cycles. So if you have more income, that leads to more consumption, more consumption leads to more production, more production leads to the need for more employees, more employees feeds back into more income and the cycle spirals upwards. However, it can also work in reverse where less income leads to less consumption, lower production, less need for employees, and then the whole cycle spirals downwards. So a recession is the phenomenon when that cycle transitions from this upward spiral to this downward spiral. And when it starts to feed on itself, it can’t really be stopped unless there’s an exogenous force. So when we look at the employment market, what we’re seeing is the very early signs of job losses in the very cyclical categories like residential construction, manufacturing, trucking and temporary help services. That makes a lot of sense. And that’s the beginnings of that downward spiral that we’re talking about. Because if sufficient job losses proliferate through that cyclical economy, then you have lower levels of income that are being produced. You’re already seeing a downturn in things like real retail sales and heavy durable goods consumption. And then you start to see the evidence that the cycle is spiraling on itself. And then that’s what polls the non cyclical or the service oriented stuff down. It’s the fact that you get that spiral going in the very cyclical employment. And then you move to the rest of the economy once the damage has been done there. So I believe that the focusing on the lagging indicators and the non cyclical indicators are not going to give you the best indication of what’s to come, you really have to track that spiral. And it always proliferates first in the beginning. So we already see the early signs of job losses in these categories. So I think there’s been a lot of premature spiking up the football for the people that are claiming that we’re going to absolutely avoid any of these recessionary conditions, we’re definitely seeing the cracks forming in all of the places where you would expect it to form first.
Adam Taggart 25:47
Okay, so if we, if we think of this as sort of like a sickness in the economy, as reflected in at least in the employment market here, you’re saying that, if we look at as a progression from very cyclical to non cyclical and whatnot, very cyclical, is infected, it’s sick. And we know the progression of contagion. And, you know, we’re now beginning to see, it’s that contagion is beginning to spread into the other sectors of the employment sector. And I’m, I’m drawing that from the trajectory of those other charts there while there was still positive growth, that trajectory seemed to be going down as we’re going across the months here.
Eric Basmajian 26:30
Exactly. Right. Exactly. Right.
Adam Taggart 26:33
I think you in your response, if you can just include this from the chart you showed earlier, where you were showing kind of three charts of the the jobs market and the very cyclical, one was tanking. But the government jobs was still pretty flat. Why is why are the headline numbers for jobs? Still so resilient? Right, you know, the unemployment rate, I think, just tick back down again, in the last jobs report. It’s still much closer to historic lows than it is to any real worry zone here. So what’s what’s keeping it from what’s keeping that contagion from being really visible to us yet in the general economy or the general employment market?
Eric Basmajian 27:14
Yeah, great question. So one of the points that I would make it every time I hear an economic indicator, I’m really enthusiastic about trying to put it in its proper sequence. So people have the context, the unemployment rate being very low is an objective fact, as you mentioned, however, a recession is not caused by the unemployment rate going up. A, the unemployment rate going up is caused by the recession. So recessionary conditions set in, in the economy, and then the unemployment rate goes up. So when the recession begins, the unemployment rate will almost always be at its lowest point where it will look the best as the recession is beginning because it tends to lead more in the direction of a lagging economic indicator. So the current position of the unemployment rate isn’t a good indicator, in my view, to dispute whether we’re headed for a recession or not, because it’s always going to look optimal, right, as the recession is beginning. The second thing that I would mention is that your analogy was exactly correct, is that the way that the economy progresses is exactly like what you said, which is one part of the economy gets infected, and the part of the economy that gets infected is not random. It’s always the most cyclical components that are sensitive to the changes that are being experienced in monetary policy and how that’s impacting demand. I just got off the phone with someone who runs a trucking company who confirmed my numbers here saying that he just laid off people for the first time in his career, because they’re experiencing a collapse in volume of freight. So the economy gets infected in its most cyclical sectors, those people become unemployed, then those people massively curtail their spending on let’s say, retail sales, which puts downward pressure on consumption. And then that starts to put downward pressure on employment of those retailers. Now we’re starting to move through the progression, and then it continues to spiral in that way. So we’re seeing the early signs of it. It’s starting to progress through what’s keeping the economy or what’s keeping the employment numbers elevated. Adam is not necessarily the strength of the non cyclicals, which you can see have already kind of come down to cycle lows. It’s the lack of huge contraction in the cyclical categories. We’re seeing the very early signs of jobs. Job losses in the cyclical categories. But if there were to be a pronounced recession, we would need those very cyclical numbers, instead of being minus three and minus eight, those would really need to be minus 60 7080 every month. So we’re seeing the signs that stress is hitting the cyclical economy, they’ve started to take the early steps of reducing their hours reducing their temporary help services, and at the very least, stop hiring. But we haven’t seen a huge flush in cyclical labor yet. And that’s mainly in my view, a result of coming off of an inflationary period. There’s evidence that when you go through an inflationary period, labor tends to lag even more than normal. Because of this money illusion where revenue stays high, while units are falling, you can maintain your headcount for a period of time, try and reduce their hours. But if that volume doesn’t pick back up, and then you start slipping out of the inflationary period and into, shall we say, deflation, then you have to take the very unnecessary step of reducing headcount. And we’re starting to see that happen now. So I would say that we have to give it a couple more months here. And if we get to, let’s say, October, November, and we don’t see more pronounced contractions in the very cyclical categories, than the recessionary conditions will definitely be pushed into 24, I would say, at this point, we have to be focused on witnessing deeper contractions in the cyclical areas, if the recession is really going to start to proliferate, because that’s what you need for that negative spiral to catch and be sort of unstoppable without some exogenous force.
Adam Taggart 31:51
Alright, so Eric, first off, let’s commit to having you come back on here in the fall, and give us an update on what your indicators are telling us then, so we know where things are going. Alright, so I’ve been resisting making this comparison. But a lot of your work makes me think of Michael Kantrowitz, and his hope framework, right. And one really important takeaway from Michael’s framework there is, you know, that’s his progression for how an economy falls into recession, also for how it climbs out of one, two. But basically, the E is the last domino to fall, which stands for employment going into recession. So knowing where we are in employment is so important. And what you’ve basically have here is a way of looking at the EA, where you’ve got your own progression inside the EA to tell us how that domino is faring, right. And you’re basically saying it’s starting to wobble. The leading indicators here are sick. They’re not yet quite sick enough necessarily to get the rest of the body to have a fever yet, but that progression is heading there. And you’re basically saying when we start seeing low negative readings on those leading indicators, that negative 16, negative seven days, that’s going to be your sign, and it’s kind of game on, did I summarize that correctly?
Eric Basmajian 33:07
Perfect, perfect example Exactly. And Cantra is great, I love his work, we think in the same terms, and you outlined it perfectly, that employment is the last one to go. But if we kind of zoom in on that employment and fan it out into its progression, we’re seeing the recessionary signs very preliminary in the very cyclical, and then the the aggregate and the non cyclical, have normalized to their trend levels, they’re not super strong anymore. You know, about 200,000, over the last couple of months, on average, that’s about normal. But the recession is really always gonna live and die by what happens in that very cyclical category.
Adam Taggart 33:48
Okay. And is there is there a challenge in the data here? So talking at a very high level with the employment rate they treat all jobs as the same that the the BLS data, right. And I believe what we’ve seen over the past year is virtually all of the added jobs that they counted, are pretty much part time that net net, we’ve actually had I don’t know if we’ve had any any growth in full time jobs. So you can you can look at it and say, okay, yes, we net net are growing jobs, but the quality of these jobs may be a real trade off, you know, if we’re, if we’re, if we’re substituting, you know, good paying full time jobs with benefits and whatnot for more part time work. That could be the sign of an actual workforce that’s struggling, right, we’re okay, I’m having to go take on a second side gig or whatever, just to keep afloat. Is there an element like that going on that you really have to kind of peel the onion back pretty substantially to really truly see what’s going on?
Eric Basmajian 34:53
Yeah, I’m so glad you mentioned that. So one of the things that I do in my process, Adam, which I think is somewhat unique is, I’m always looking at a basket of indicators rather than any individual indicator. Because while any individual indicator may have, let’s say, like a 90% success rate, there’s not a single indicator that that doesn’t fail at turning points at least once over a long period of time. But if you take five or six variables that all independently have a 90% success rate and you aggregate them together, the whole collective basket is unlikely to give a false signal as much as one indicator might. So the same way that in that aggregate economy index, I’m combining six variables. I have a coincident employment index that aggregates five employment indicators into one composite. And what I’m aggregating here, Adam is the nonfarm payrolls number that we all know, the household survey, that’s a little bit lesser known, the unemployment rate, which you mentioned. Now, this is we’re tackling your question, I’m looking at aggregate weekly hours. So the hours people are working times the number of people. And then I’m also looking at the insured unemployment rate, which comes from the continuing jobless claims data. So we’re able to sort of filter out some of that noise, because we’re picking up some of the weakness in that aggregate hours indicator, which is falling much more rapidly than non farm payrolls. So when we take those five indicators, and you smash them all together, and you plot them as one composite employment index, what you’ll notice is that with zero false flags, when this indicator moves negative, you’re already in a recession, sometimes deeply. So like in the 1974 recession, the most left on the chart here. So a objective basket of those five measures, is only growing at a 0.9% pace. So what this tells me with I think a pretty good level of objectivity is that the non farm payrolls, the singular statistic that everybody looks at is overstating the strength of the labor market. Because when we look at a more broad basket of a five variables that kind of see, through the part time issue, the full time issue, the hours issue kind of puts them all together, we’re very narrowly out of recessionary territory. So we’re not quite there yet. It’s very similar to the stuff that we were looking at earlier, which is, the economy has kind of, in a very abrupt fashion moved right to the cusp of recessionary territory. But it’s refusing to kind of push through that zero bound, whether we’re looking at aggregate economic activity or employment, most specifically. So I agree with your assessment that our non farm payrolls numbers are giving a probably overly optimistic view of what the true situation in the labor market is. Because while we’re seeing net payroll additions, we’re seeing these huge declines in hours worked a lot of that, because we’re replacing part time labor and things like that. So I try and filter through some of those issues by looking at these broad composites. And of course, I’m presenting all these indicators to clients. And I’m obviously happy to come back in the fall to see if we crossed the zero bound on this measure here.
Adam Taggart 38:41
All right, good. Thanks for being gamed for that. I’m going to ask you to speculate a bit here, which is does the Fed look at this data, you know, in the type of detail that you do? Or is there a danger that if they’re keying policy decisions off of this sort of overly rosy, NFP data that’s out there, that they may think that they need to be more aggressive in continuing to tighten in the inflation fight? Because what they’re trying to do is bring demand down. Right? And in theory, they’re trying to kind of create some job loss, right. So if they’re looking at an unemployment number, like this thing, still not budging. We gotta turn things up even higher, or on the tightening and the hiking, then they’re in danger of basically over tightening. Yeah, making the recession worse than it otherwise should be. Do you have a concern about that?
Eric Basmajian 39:36
Are you implying the Fed could be late, Adam?
Adam Taggart 39:39
Actually, I’m implying they could be. Remember,
Eric Basmajian 39:41
I can’t remember any other time where the Fed missed the missed the ball. But I think to answer your question more, more directly is it would be sort of silly to sit here and say that the Fed has 1000 PhDs and they don’t know how to look at indicators like this, but I think it really comes down to a an ideology of In a difference in the way that people look at the economy, so I’m a business cycle guy. And I look at the sequence of economic indicators, and I take my signal from that sequence. But the Fed almost all of the people at the Fed and all of the alumni of the Fed like Janet Yellen, or Neo Keynesian labor, economists, meaning that they view the economy from labor outwards, so they see a low unemployment rate. And to them, that means lots of consumption, lots of inflation, and they view unless they get the unemployment rate up, the rest of the variables aren’t going to move. They don’t necessarily subscribe to the theory that the indicators that they control, like monetary aggregates, impact labor, they’re kind of viewing it from labor outwards, the whole process starts with Labour versus ends with labour in my process, and Cantra, like you mentioned, and some other folks that are doing some business cycle work. So I think it’s entirely different in the way that they’re going about it. And that’s sort of the genesis of the Phillips Curve. And even though it’s been debunked time and time and time again, they’re still somewhat dogmatic to the Phillips Curve, and that the unemployment rate is what drives the inflation. And it’s really just a, you know, almost like a difference in political views. There’s, there’s left and there’s right, and there’s no middle ground. There’s the labor forward, or labor centric economists, which really dominate the Fed, there’s no diversity in terms of a pin ideology there. And then you have some other folks that are doing business cycle work that that sort of look at this progression and are saying, Hey, you guys should be really keying off some of his earlier looking indicators, not so much the lagging stuff, it would it would prevent some of the situation that we’re in, which is the Fed oftentimes booming the booms and then busting the busts. Which is, which is what happens a lot.
Adam Taggart 42:03
Okay, so I’m taking from your answer here that you think that yes, there is a risk here, that the Fed is basically going to make this recession worse than it needs to be?
Eric Basmajian 42:12
Exactly. And the analogy, I think it was, I think it was coined by Milton Friedman is that monetary policy lends itself to what’s called the Fool in the shower. So if you think Adam, if you jump into the shower, and you turn the temperature gauge from cold all the way to hot, it doesn’t immediately come out as hot water. So the Fed keeps turning and turning and turning, and then eventually it comes out. And it’s called them, right. So that’s the analogy of monetary policy, which is they keep turning the dial and the water that’s coming out as the unemployment rate. And they’re like, Hey, we turn this thing all the way to hot, it’s not coming out hot yet. Let’s keep going. And then it comes out. And it’s calls them which is the unemployed unemployment rate in a short period of time, climbing from three, six to three, eight to four, two. And then here we are with monetary policy that miles above what most people would deem as the neutral or equilibrium rate.
Adam Taggart 43:09
All right, you’re I’m searching for a tweet, as we’re talking about, as we’re talking right here. I’ll see if I can find it. But it was basically somebody who was saying, Boy, I hate to admit it, but it looks like Jerome Powell might be doing the impossible here. And managing, you know, a soft landing of the plane here with the economy, with, you know, inflation coming down and us not being in recession and home prices haven’t cratered. And all that type of layoffs haven’t really picked up that much. I think what I hear you saying is, you know, just wait.
Eric Basmajian 43:44
Yeah, exactly. So I’d love to key on home prices, too, because there’s a lot of talk about that, again, let’s contextualize where everything goes in the sequence. So we have our leading, or cyclical, or aggregate or aggregates where that E or that employment falls in if we add a fourth curve, a fourth sine wave, that’s our lagging indicators. That’s where inflation is inflation lags the business cycle. And home prices can be thought of as home price inflation. So if you think about housing, you have to separate housing into volume, which is like real growth and prices, which is like inflation. So what have we seen in housing, we have seen a crash in volumes, right? The whole massive a home price decline is inflation. That’s gonna that’s gonna lag the cycle. So So yeah, I think exactly where what’s what’s interesting about this decline in inflation that we’re having is we have this abrupt slowdown in inflation, before the economy goes into its full recessionary cycle. The inflation rate often bottoms 12 months after the inflation ends. So let’s just give a hypothetical straw man Adam, if the recession, let’s say started in June of 23. And we realize that with hindsight, and it lasts a year, and it lasts until June of 24, inflation won’t bottom until June of 25. And that’s when home prices but also bottom because they’re in that inflation buckets that just kind of hopefully paints a picture for everyone about how these cycles progressed and how they can take time. The economy went into this imminent recessionary phase, Adam in in the first quarter of 2007. But most people don’t realize the event of the recession until almost 18 months later with Lehman Brothers. And then home prices didn’t bottom out until almost 36 months after the initial imminent recession phase, and really 2010 and 11. So sequence matters, things don’t happen overnight. Home prices and inflation, these are long cycles. And we’re going to have a continuation of those things declining, but the bulk of their decline is going to happen after the recession. All the decline that we’ve had in inflation so far, has really nothing to do with monetary policy. It all the monetary policy induced inflation decline will be a result of the lagged business cycle effects. I think that’s wildly misunderstood right now.
Adam Taggart 46:19
That’s so interesting. Well, let’s keep diving on that. I want to put up one monetary chart here real quick. So I just saw this this morning. So what we haven’t talked about monetarily is money supply. So if you can see this chart here, the red line is the percent change year over year in m two, right, which is the money supply. And you’ll see here its correlation with the inflation readings, right CPI, PPI PCE, it’s a very tight correlation. And what they’re showing here is that the change in m two, the percent change in m two, that leads the other data, the inflationary data by about 16 months, you know, roughly a year and a half. Right now, we have a negative growth in money supply. It’s something we’ve we’ve almost never seen in the entire historical data set. So very rare. So if this relationship holds, we would expect to see inflation continue to come down all these inflation measures can be condemned, but but but actually come down so that we’re no longer in disinflation, but actual real deflation. So I’m curious to get your thoughts on this, because that is a more monetary indicator, right with money supply. Yeah. But it plugs it complements nicely what you’re talking about with the business cycle,
Eric Basmajian 47:48
exactly in concept, I fully agree. And monetary aggregates like money supply, and two would be in our most leading components. So again, just going through this progression, we have our leading, which is where those monetary aggregates would be filters through to our cyclical, then we hit our aggregate and then we hit our inflation. So I also agree with the rough 16 months time horizon. And it’s always difficult to say it leads by exactly 16 months, because it’s variable from cycle to cycle. But something in that ballpark is what we would experience looking through those different sine waves. And given the extent of monetary tightening that we’ve seen, and also given the fact that inflation has declined very substantially before the recession has officially gotten underway. I do think the risk of outright deflation is quite high, particularly in the back half of the recession, and in the six to eight months following the recession. So I do think deflation is a very real possibility. It’s not upon, it’s not going to happen tomorrow. But it will be part of the business cycle sequence. And if we do go into official recession, then you’re going to have the bulk of the decline happen after that. So all the decline we’ve experienced so far, is not entirely related to that monetary phenomenon.
Adam Taggart 49:13
All right. Well, look, I’m looking at the time here. I could go another couple hours with you, Eric. So I gotta start landing the plane, we’ll have you back on to dive more more deeply into some of these things. But to really get to where the rubber meets the
Eric Basmajian 49:24
road, that was a soft landing analogy.
Adam Taggart 49:26
Yeah, hopefully, hopefully, we have one in this interview. So from what I hear you saying you it sounds like you think we are going to go into recession here. Again, you can come back on this program, many times to tweak your, your predictions for us as you get more data. But given the data you’re looking at right now, sort of when do you expect it to be visible, you know, to the average viewer here that’s in their lived experience. And in terms of, of landings, you know, hard or soft, bad recession, mild recession. What kind of intensity are you expecting?
Eric Basmajian 50:08
Yeah, so that’s a really good question. And I’m just going to try and not sound like I’m beating a dead horse here. But when people are thinking about recession, it entirely depends where you fall in these different cycles. So for example, I was mentioning a trucking executive that I was just speaking to the recession is on full blast. For him. It’s they’ve been in a downturn revenues are struggling, they’re starting to lay off employees for the first time ever. They’re definitely experiencing a recession already. If you’re a real estate agent, let’s say and you are paid off of transaction volume, you’re definitely experiencing a recession in your income and the volume of your activity. But if you’re an s&p 500 investor, or you’re more tied to the services economy, you probably haven’t experienced the recessionary conditions yet. So it’s not exactly a point in time, it’s more of this process. And I would say that the recession is definitely taking hold in the very early parts of the cycle, I would expect it to transition to the more aggregate economy in the back half of this year in the first half of 24. But what I would say is that since we’re in this imminent recessionary window, you know, if it happened two months ago, it would make sense, if it happened two months from now, it would also makes sense. When we get into these windows, we are vulnerable to shocks that occur and a lot of different exogenous factors. So I would say that, as best as I can, as I can say is, you’ll experience the recession in the order in which you fall, if you’re very much on the leading edge of the economy. If you’re a residential construction worker, a temp worker, manufacturing worker or trucking, you’re probably starting to feel the onset of these recessionary conditions. Next, you’re going to start to bleed through to the broader sectors like retail and things like that. And if you’re in non residential construction, you’re not going to experience it for some time. But most people, if you’re listening to this call, and you’re, you know, a stock market or s&p 500 investor, that tends to be most correlated to the aggregate economy. And in that case, I go back to the answer, which is, you should really start to experience some of these conditions in the broader economy in the back half of this year and and the beginning of next year. That’s how I would go about framing the recessionary conditions.
Adam Taggart 52:39
Okay, we have a free guide here at Wealthion. It’s called the layoff Survival Guide, it’s got a bunch of basically recommendations that you should take, before you think you may get laid off. If you work for a paycheck. It also has got a lot of advice that you should take upon getting a pink slip things that you should be doing right immediately after that. I’m going to put words in your mouth here. But it sounds like you think if someone is working for a paycheck, they should probably read that guide pretty soon. Because it sounds like what you’re saying if this is going to hit the aggregate economy, the latter half of this year, probably there’s not that much time left, you want to start getting prepared for Yeah,
Eric Basmajian 53:22
I would think that’s a good idea. I mean, given this trajectory, if it doesn’t happen, great. But it’s something that’s certainly a big risk. And one of the things that I help clients do is really understand where they fall in this sequence. And it kind of gives them a sense of maybe how much time they have. So if you are in that cyclical economy, you’re definitely at, you know, what I would call imminent risk, you’re seeing early job losses there, and you’re not seeing a big pickup in some of the forward looking indicators. If you’re, you know, really deep in the non cyclical stuff, you might have a little bit more time. But But yeah, I would say that anyone on the leading edge is is is I would say, running out of time, unless these indicators really start to pick up which given the pace of monetary tightening and what’s unlikely to be a huge pivot in the next. You know, couple of weeks here, I’m I’m not, I’m not assuming that these forward looking indicators will have an about face and shoot higher.
Adam Taggart 54:26
Okay. All right. And just for folks who are interested in reading that free guide, just go to wealthion.com/layoffs. You can download it there for free. Alright, so in a very unfair few minutes remaining. Eric, let’s talk about how this manifests in the markets. Right. So what is your let’s talk about both the financial markets and the housing market. We already talked about housing a little bit. Sounds like you think that’s gonna go down further from here and that’s, I’m gonna guess it’s going to start being truly game on in the housing market. By the way, folks, if you want to figure out where they housing markets going and you want to hear from a dedicated housing analyst just released a video with Nick Gerli. This week diving deep into that. So if you want to watch that after watching this video, I’ll put up a link to it right here. But but in terms of the the financial markets, the stocks and bond markets, what are you expecting as this recession really begins to arrive in force? Yeah. So
Eric Basmajian 55:21
I would say that, that that asset markets, generally speaking, and by assets, I mean, risk assets are certainly overly optimistic about the trajectory the economy is heading on. And that’s not super unusual. What’s what’s fascinating about stocks is people often say stocks are a leading indicator, and that is true. However, they’re not great leading indicators at peaks, they’re very good leading indicators at troughs. And when you take the average of the two of them, they’re on average, a leading indicator, but you can be really caught blindsided, if you’re assuming that stocks will give you the forewarning of something to come. So I would say that overall stocks tend to respond most aggressively to changes in labor market data. So once we see the initial and continued jobless claims have a move that to broad market participants looks like it’s irreversible, you know, a very sharp move higher, that’s likely when asset markets will respond to those recessionary conditions.
Adam Taggart 56:26
In sorry to interrupt but back to kind of your magnitude of what you think might be coming, like, what numbers should we be looking for? Like, do you expect when this really gets going, we’re gonna have months where we’re losing hundreds of 1000s of jobs so that we didn’t know eight or a one.
Eric Basmajian 56:41
Yet magnitude is is definitely harder to predict them direction. And I’m not trying to cop out of that answer. But the reason is, because it really does depend what shocks come along the way when you’re in that recessionary period, because if we remember, a recession is that negative economic spiral between income consumption, production and employment. And when that ball gets rolling down the hill, it’s really hard to predict what things will blow up along the way. And those blow ups are kind of unpredictable, but really will kind of ultimately determine the magnitude in climax. So I will say I don’t have as much confidence in the magnitude. But we can have clues about the magnitude. And the best we can do is the extent of monetary tightening and how much restraint the Fed puts on the economy. And on that basis, I would have to tilt the scales towards something larger in magnitude given that we are already experiencing what I would consider early recessionary or pre recessionary conditions. And the Fed hasn’t relented yet, which they already did in Oh, seven and earlier cycles. They were at the at the very least on pause when the economy entered this imminent recessionary phase economy ultimately went into recession anyway. But the fact that the Fed is tightening, so deep into this one, has to in my view, tilt the scales more in terms of magnitude. I don’t I don’t have the confidence to put an exact number on it. But I wouldn’t say that this would be a recession like 2000, which was quite mild. I would, you know, it’s hard to say it’s going to be, you know, like 2008. But I would say it’s going to be deeper than average, given the extent of monetary tightening.
Adam Taggart 58:35
Okay. And in terms of a stock market correction from where we are right now, and you’re saying the market seems to be pretty sanguine, maybe a little magical thinking in there right now. We haven’t even talked about AI yet, but that’ll be for a different day. You know, I’m not trying to pin you to a number but just sort of in terms of the the correction you expect in the market. How substantial you don’t have to give me a percentage, but you can say mild, moderate or severe?
Eric Basmajian 59:06
Well, I would, I would certainly expect the broad markets to make new lows. So that would be through the October lows, if the economy does go into recession, as I expect, and you know, it’s really tough to say in terms of magnitude, but I’ll throw out a somewhat average recessionary declined to let’s say, something in the vicinity of 30% peak to trough if, if there was a gun to my head, which hopefully there is not but I would say that that’s that’s something in the ballpark of what I’m saying. Because if I go out there and say 40 50% There are such outlier cases that the odds would be stacked against that prediction and people would hold my feet to the fire, but I would say that given the extent of monetary tightening, given the high valuations that asset That’s currently have heading into the recession, that you’d have to tilt the scales towards a more more than average recession and perhaps more than average correction and asset prices. But that correction and asset prices won’t be at its most forceful until we see the visible signs of stress in the aggregate labor market. And right now, we’re only seeing in the very early and cyclical parts of it. So the stock market potentially has a window here where it can enjoy what looks like maybe the end of the Fed tightening cycle, but not yet the full collapse of the of the labor market, but it can happen quite abruptly. So I would be worried about trying to thread the needle a little bit too closely. But that’s my general take on on the situation and risk assets.
Adam Taggart 1:00:52
Got it. So what I hear you’re saying to today’s investors, as don’t get too comfortable in what sort of feels like a false summer in the markets right now.
Eric Basmajian 1:01:00
That’s right. And Adam, I would also say that, you know, we always say the market as the s&p 500. Let’s be honest, that’s what the market is. But I would say, again, that question kind of depends on what asset you’re talking about. Because the progression of assets is very similar to the economic cycle in the sense that the more esoteric, or on the peripheries, you are, in terms of the assets you’re playing in the earlier they’re gonna see signs of stress. So if you’re in, you know, a really out of the box, private credit type of market, you may have already frozen. If you’re in commercial real estate, the time to get out was over a year ago, it’s only the s&p 500, that tends to hang on towards the end, because it’s liquid, it’s very much at the core of the system. So I would say that, you know, when you’re thinking about how assets are going to respond, think about where that asset falls in the spectrum, and then try and relate that to that spectrum of the economic cycle that I was referring to. And that may help give some some indications of timing, s&p tends to be a little bit more lagging some of your real estate stuff, since it’s so illiquid, the prices haven’t declined yet, but it may be difficult to transact at what you think are the current prices?
Adam Taggart 1:02:13
Yeah, that’s a great point. Be careful of when you go to sell to see if there’s any liquidity. All right. We’re gonna go over by a few minutes, folks, sorry, but these are important questions. So on that point, then, given where we are in the cycle, if we are close to sort of a realization of, okay, we’re going into recession, things aren’t, we’re not going to achieve escape velocity, the way that we thought, the boom comes off the rows on the party and stocks. You know, what asset classes tend to perform well at that part in the cycle, and I’ll precede this a little bit. And you can correct me, obviously, cash probably could hold, I would think, US Treasuries good to hold. Though, that might be the moment where folks that are going out longer. And the duration curve, we’ve had a lot of discussion about when the time to do that is my guess is you’re saying we’re probably getting closer to that time, because when folks rush in, the price of those bonds will go up. And that’ll be felt most on the long end of the curve. I’m gonna guess maybe safe haven assets, like precious metals might be popular, but I don’t know, what do you think
Eric Basmajian 1:03:24
you summarized it perfectly? That’s exactly what I say. I would say that, you know, if you had to put a bucket of assets together that would perform the best in an in a recessionary period, it would be your cash treasury bonds across the curve. And I would say gold would be in there as well. Although, in a recessionary period, gold could decline in value, but it tends to hold up better than the more industrial commodities and risk assets broadly. So those are definitely the assets that I would be holding in the environment that I believe that we’re heading towards.
Adam Taggart 1:04:03
Okay, well, sorry to steal your thunder there. But it’s great. Right?
Eric Basmajian 1:04:08
That’s exactly right. And like you said, cash is great. optionality is great. And then also, you know, this would also be a time to perhaps hold long volatility positions or anything like that these conversations about which acids can get super complex, but from a very high level, I would, I would echo exactly what you said,
Adam Taggart 1:04:27
Okay, great. When we have you want to get in the future, I promise, I’ll devote more time in the back half of the conversation to be able to explore this discussion, because it’s super of interest to the folks watching, obviously, and I want to give you a chance to give your full thoughts on it. But we don’t have that time right now. So we’re gonna have to start wrapping up. So Eric, it’s been a great conversation. I’m so glad we finally made this happen. I look forward to having you back on the channel in the future. For folks that have really enjoyed it and perhaps maybe weren’t aware of you and your work beforehand. Where can they go to follow you?
Eric Basmajian 1:04:58
Great, and thanks for having me on Adam. I’m a huge fan of the show. And all the success you’ve had for has been really fantastic, very kind. I am on EPB research.com is where you can find all of my work, I have a blog that I kind of post some various thoughts about this business cycle and business cycle sequence. And then I also provide really three tiers of service, I have a weekly report, which is my, you know, quick thoughts on any economic data that has come out as as it pertains to this economic cycle sequence, I have a monthly report, which is my flagship report, which really goes through this whole process in extreme amounts of detail every single month. And then I also have some some private consulting, where I’m working with institutional asset managers, or corporations, like manufacturing companies, and helping them understand where they fit in the cycle, what indicators they should be looking at, to get an advanced warning of where things are coming, and helping them with their strategic planning. So all of that can be found on EPB research.com. And if you want to contact me, there’s a Contact button, shoot me a message, we’ll jump on the phone, and I’m happy to try and discuss how I can help.
Adam Taggart 1:06:14
Awesome, Eric, when we edit this, we will put up the link to your EPP research.com website where everybody knows exactly where to go. I also put a link in the description of this video as well. This has been wonderful, folks, just in conclusion, as we do every week, we recommend that folks navigate this highly uncertain market. And Eric’s done a phenomenal job of really giving a lot of clarity to the potential progression that we could see coming forward from here and all of the turbulence that that may bring to the financial markets. So we highly recommend that you navigate this working under the guidance of a professional financial advisor who’s who’s good, just as a foundational point, but who takes into account all these macro issues that Eric’s been telling us about. If you’ve got a good one who’s doing that for you, who’s putting together a personalized portfolio plan for you, and then implementing it for you while keeping you well involved? Stick with them. Those people are rare, they literally are worth their weight in gold. If you don’t have one or would like a second opinion from when you does, and consider scheduling a free consultation with the financial advisors that Wealthion endorses to set up one of those consultations just go to wealthion.com Fill out the short form, there only takes you a couple of seconds. And these free consultations are totally free. They don’t cost you anything. There’s no commitment to work with these advisors. It’s just a public service that they offer to help as many people as possible, prudently position in advance of developments like the ones that Eric has been telling us about here. If you’ve enjoyed having Eric, join us half as much as I have, please encourage them to come back by supporting this channel and hitting the like button, and then clicking on the red subscribe button below. As well as that little bell icon right next to it. Eric, it’s really been a pleasure. I’m so glad we got to do this. I really look forward to having you back on the channel in the future. I really look forward to having you in the staple of our ongoing experts here. You’re a younger guy. It’s really great to see the new generation of talent rising in this market. We didn’t even get the chance to talk about one of your mentors, the great Lacey Hunt, a huge fan of him. He’ll be coming on the channel in just a couple of weeks. But really glad to see guys like you rising up in the ranks here.
Eric Basmajian 1:08:25
Thanks, Adam. Thank you so much for having me on giving me a chance to explain what it is that I do. And I’m an avid watcher of all your videos and I’ll definitely be glued to the Lacey hunt one in a couple of weeks. So thank you again.
Adam Taggart 1:08:37
All right, everyone else thanks so much for watching.