What the Next Recession May Look Like
By Megan Horneman. © Verdence Capital Advisors
- Recession warning signs flashing.
- Consumer is most important component of GDP.
- Consumers have been resilient thanks to massive covid-era savings.
- Consumers better positioned relative to entering past recessions.
- Strong labor market can help consumers.
In recent weeks, investors have absorbed many key economic data reports that suggest a recession may be unavoidable. Last week, one of the most widely followed recession indicators (10YR – 2YR U.S. Treasury yield curve) inverted. This reflects concerns about long term economic growth. According to Bloomberg, the chance of a recession in the next 12 months now sits at 33%. While recessions are a normal part of all economic cycles, it is important to look at the underlying fundamentals of the economy to see how hard of a contraction we may be in for. Aside from the self-inflicted pandemic recession in 2020, the last recession most remember was the brutal, Great Recession of 2007-2009. At this point, we believe when the next recession occurs it will likely be a consumer-led pullback. Therefore, analyzing the condition of the U.S. consumer, especially compared to prior recessions is useful at this point in the cycle.
State of the Consumer: The consumer makes up ~70% of U.S. GDP so typically if the consumer spending goes down, so goes GDP. Consumers have been resilient during this period of heightened inflation. This is partly due to the roughly $5.0 trillion in savings that was amassed because of covid-era stimulus payments and lockdowns that curbed demand. However, as the economy has reopened, consumers have splurged and prices on everyday necessities have skyrocketed, consumers have wiped away that savings.
Consumer to Slow but they are Stronger Than Leading into Past Recessions: The level of consumer spending is not sustainable, especially with real wages being dragged lower by higher inflation and credit card debt growing at the fastest year over year pace since 1997. On the bright side, the pullback may be shallow for several reasons. While, savings are weak, consumer wealth in real estate, investments, and banking accounts as a percent of disposable income is at a record high. With net worth currently at ~820% of disposable income, it compares to only 650% and 615% leading up to the 2007 and 2001 recessions, respectively.
Labor Market Remains Strong: The labor market is typically a lagging indicator. Companies lay off employees after growth has already slowed. However, the complexities created from COVID, such as the labor force participation not being at a pre-pandemic level, suggest strength in the labor market can continue.
A recession is likely unavoidable over the next 12 months. At this point, we think it will be a consumer-led recession as consumers cannot keep up with the surging prices of nearly all everyday necessities.
This material was prepared by Verdence Capital Advisors, LLC (“VCA”). VCA believes the information and data in this document were obtained from sources considered reliable and correct and cannot guarantee either their accuracy or completeness. VCA has not independently verified third-party sourced information and data. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice. This material is being provided for informational purposes only and is not intended to provide, and should not be relied upon for, investment, accounting, legal, or tax advice.
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