At the beginning of last year I began reporting in this newsletter that a recession seemed to be in our future. What I was seeing then was that the relationship of long term and short term interest rates were backwards. This type of interest rate “inversion” has always been one of our most reliable indicators of a developing business slow-down and often an outright recession.
The U.S. economy surprised me by staying healthy as long as it has. Normally when the interest rates invert we will see a recession within 6 to 12 months. It’s been more like 20 months since this latest inversion began so this indicator was beginning to look broken until recently. I think the latest in a string of financial bubbles, the debt bubble, has kept things afloat. The cash that came from new mortgages and home equity loans really boosted the economy, but that extra push is now gone as the mortgage markets dry up.
A recession won’t be formally announced by the government until after two full consecutive quarters of declining economic activity have been recorded. What this means is that you won’t know we are in a recession until at least 6 months, perhaps as much as 9 months after the economy has actually stopped growing and started shrinking. Waiting for a formal pronouncement won’t be much help for savvy investors who like to plan ahead. This is one reason I have to stay on my toes so much here at Hepburn Capital Management. I look ahead a lot.
Since building my new office this spring, I have had my ear close to the ground in the construction and real estate industry. My unscientific surveying of workers in these two industries tells me that they are already experiencing a recession. We hired a new admin person last month, and the numbers of resumes we received from people laid off from construction offices was startling. Excavators are selling heavy equipment. We called trades people and often they were there the same day. This was unheard of a few years back. Several real estate friends have quietly taken jobs in other industries. One Realtor said, “This is not a buyers market, there is NO market”. And Prescott’s market is known for stability so I assume it is better than most.
Considering that construction and real estate industries make up about 8% of our country’s economic activity, perhaps more in go-go markets like Arizona, a slowdown in those industries is a big deal. If half of construction and real estate grinds to a halt, our roughly 4% economic growth rate of years past may go to zero. The unemployed or under-employed crowd is not likely to buy new cars or take vacations or eat out, so the ripple effect may be expected to reach other jobs and push the country firmly into recession.
How certain is all this? I don’t know for sure. But folks in these two industries don’t need to be told a recession is afoot. The Government’s Jobs Report on September 7th was downright dismal. And the stock market responded with a large decline.
As of this writing, investors and pundits alike are all waiting with bated breath for the Federal Reserve Board’s meeting next week at which the Fed is expected to lower their targeted “Fed funds” rate and help shore up an economy that is visibly slowing. Will the Fed lower? Yes, they will. The market rate for Fed funds has been ¼ to ½% below the Fed’s targeted rate for over a month now. The markets are telling us we will see lower interest rates going forward.
But does it make any difference? Not really. The Fed no longer leads the market; they just follow the supply and demand for money, the price of which is quoted in interest rates. Thirty years ago the US Government was able to set interest rates and used this tool to control the economy. However, decades of deficit spending have moved control of the interest rate markets to the holders of the several trillion dollars worth of bonds we sold to finance the deficits. These markets have been leading the way toward lower interest rates, so I will be surprised if the Fed does not move to get in step with the market at its meeting next week by lowering its rates, too. After all, we can’t have the world seeing that the Emperor has no clothes on.
This decline of interest rates is another sign of impending recession. You already know that interest is the price that can be demanded for the use of money. The price lately is clearly down, meaning demand is down. And the demand for money increases as businesses borrow to expand, and it decreases as business stop borrowing to expand. If businesses are not expanding then they are _______ing. There, now you understand how it works.