Cracks Appear in the U.S. Economy
The U.S. economy is starting to crack and a recession could be around the corner. Investors beware: the period before the economy enters a recession is generally dreadful.
As it stands, the economic data has started to turn. An early indicator of an economic slowdown was that U.S. gross domestic product (GDP) declined in the first quarter of 2022. That decline caught almost everyone by surprise.
Note that GDP is a lagging indicator; it tells us what has already happened. Investors need to pay close attention to coincident and leading indicators of the U.S. economy. Coincident indicators are data sets that tell us what’s happening with the economy right now. Leading indicators are economic data sets that tell us what could happen to the economy in the future.
U.S. Retail Sales Declining
One leading indicator worth watching is retail sales. It essentially tells us how consumers are feeling about their financial positions. Since consumption makes up a huge portion of U.S. GDP, if retail sales decline, it could be a sign that the economy is in trouble.
See the chart below. It plots the year-over-year change in monthly U.S. retail sales.
(Source: “Advance Retail Sales: Retail Trade,” Federal Reserve Bank of St. Louis, last accessed June 16, 2022.)
There’s been a significant deceleration in U.S. retail sales over the past year or so. In May, U.S. retail sales registered a decline for the first time since the beginning of 2022.
Furthermore, consumer sentiment is currently in worse shape than it was back in 2008–2009. Know this: pessimistic consumers watch their spending carefully and refrain from buying high-ticket items.
Adding more to the misery, the saving rate in the U.S. has been falling quickly. If savings drop, will consumers buy fancy cars, big houses, and flashy gadgets?
U.S. Housing Market Taking a Tumble
The U.S. housing market also has an impact on the overall U.S. economy. The construction industry hires a lot of people, and with a strong housing market, other industries benefit as well. If the housing market struggles, it could be bad news for the economy and increase the odds of a recession.
Look at another chart below. It plots the sales of new homes in the U.S.
(Source: “New One Family Houses Sold: United States,” Federal Reserve Bank of St. Louis, last accessed June 16, 2022.)
As the above chart shows, there’s been a massive deceleration in new home sales this year. In December 2021, the annualized pace of new homes sold stood at 839,000 units. As of April 2022, it stood at 591,000 units. This represents a decline of 30% in the matter of a few months!
New home sales are just one indicator of the housing market. Other indicators—including existing home sales, housing starts, and pending home sales—also suggest there’s a significant cooling of the market.
Mortgage lending activity in the U.S. (another indicator of the housing market) has also been dire recently. According to the Mortgage Bankers Association, as interest rates have climbed, mortgage applications have dropped to their lowest level in 22 years! (Source: “Mortgage Demand Falls to the Lowest Level in 22 Years Amid Rising Rates and Slowing Home Sales,” CNBC, June 8, 2022.)
As Economic Slowdown Approaches, Caution Required by Investors
Dear reader, a recession is starting to look inevitable now. Even big banks are saying it, and I’m sure that the calls for a slowdown will get louder.
Recessions are bad for the stock market. The market typically moves ahead of an economic slowdown. The stock market tends to top when the economy is approaching a peak and the stock market tends to bottom when there’s peak uncertainty. The period between the economic peak and the peak uncertainty is treacherous. You’ll see wild price action and rigorous selling—something like what we’ve been seeing with key stock indices these days.
We certainly aren’t at peak uncertainty just yet.
I can’t help but preach caution. If you think the stock market has been volatile since the beginning of 2020, you must ask what will happen when the economic data confirms the fears of investors. There could be a lot more selling of stocks, and key stock indices could go down by a bit more.
However, I’ll end on a positive note: as the selling of stocks persists, there’s some value being created. There are opportunities popping up. It could be a great time to start looking for stocks with potential, but a lot of research will be required.