The Breakdown - A K-Shaped Recession?

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and Ft, and produced and distributed by CoinDess. What's going on, guys? It is Friday, July 15th, and today we are talking about a K-shaped recession. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure as always, in addition to them being a sponsor of the show,

Starting point is 00:00:47 I also work with FTX. Lastly, this week I am also excited to welcome Ava Labs as an additional sponsor. Did you know you can bridge Bitcoin natively across the Avalanche bridge and take advantage of the growing DeFi ecosystem on Avalanche? This is just one of the innovative features of Core, the new non-custodial browser extension and wallet developed by Avalabs. Core is engineered for Avalanche users to have the most secure and seamless Web3 experience. Easily swap assets, display your NFTs in style, and store your assets in a ledger-enabled wallet. Plus, you can put real dollars in your Core wallet in just a few clicks. Go to core.app to access the full power of Web3 on Avalanche.

Starting point is 00:01:27 All right, friends, today we are asking the question that will absolutely dominate financial media for the months to come. Are we headed into a recession? Or, in fact, are we already there? Now, what's clear is that we are in the midst of a narrative shift. Inflation seems incredibly persistent and sticky, which means that the Fed is being affirmed in their efforts to do whatever it takes to beat back inflation before it becomes some decade-long nightmare like we had in the 1970s. As you heard on Wednesday, Jerome Powell and the Fed are incredibly focused on not repeating the mistakes of Arthur Burns. the Fed chair who took his foot off the brakes too early, paving the way for the necessity of

Starting point is 00:02:06 Paul Volcker's massive hikes at the end of that decade. But because of this assessment that nothing matters more than not letting inflation become endemic, it means that the Fed is a lot more willing to deal with collateral damage, specifically causing, or at least not helping stop a recession. There is very much a, if that's what it takes attitude emanating from the Fed right now. So now the media narrative isn't just inflation, which we've been discussing for my months and months and months, but the big R-word as well. Today we're not going to look at just media prognostications about recession or even market signals necessarily, but real-world data to figure out, not just whether we're in a recession,

Starting point is 00:02:44 but just broadly how we're doing. Let's start with real estate, where, of course, for the last couple of years, we have just been in a blistering market. Now, however, housing is beginning to show some signs of weakness. According to Redfin, nearly 60,000 home sales fell through in June. That represents 15% of all transactions. actions, which is the highest level since April 2020. There are numerous reasons being pointed to. Average mortgage rates have hit 5.51%, almost doubling in the last 12 months. And while that may not sound like much, the way that mortgages are structured with so much more of the payment being on interest up front means that that doubling is significantly reducing borrowing capacity for

Starting point is 00:03:23 home buyers. Increasingly, they are being priced out based on monthly payments, not just high home prices overall. Sam Catter, the chief economist at Freddie Mac, says with rates the highest in over a decade, home prices at escalated levels, and inflation continuing to impact consumers, for portability remains the main obstacle to homeownership for many Americans. On top of that, new tax assessments based on those escalated home prices from the last couple years are starting to hit the market. Some buyers are walking away after seeing taxes double on revised assessments in high land tax regions like Texas. We're also seeing the beginning of price drops, especially in specific markets that were particularly puffed up during the pandemic. In Boise, Idaho,

Starting point is 00:04:02 more than 60% of homes on the market saw price reductions in June. Denver and Salt Lake City also saw more than 50% of homes with reduced pricing. According to Zillow, home values in seven of the 100 biggest housing markets fell in June. That includes four cities in California, plus Austin, Texas, Seattle, and Ogden, Utah. Now, the main culprit of this is that inventory shortfalls in this region that were seen as a large driver for pricing increases began to normalize, which reduce the perception of scarcity. But there's also an open question if tech sector and startup layoffs

Starting point is 00:04:32 as well as the reduction in the value of stock-based compensation is starting to show up in these markets. Despite all of this, though, average home prices in the U.S. are still increasing. St. Louis Fed President James Bullard said it wouldn't surprise me if we have to cool off some in the housing market.

Starting point is 00:04:48 I mean, that was a boom, an absolute boom, in the last two years. And even now, I'm not so sure that the prices are really coming off, at least in the aggregate statistics. The number of homes for sale rose by 2% in June, which is the first time in three years that inventories have increased. So in total, we have a supply of houses that's finally, finally starting to, if not catch up with demand, be a little bit better than the shortage that was causing

Starting point is 00:05:10 so many problems before, but that's hitting right at the same time as mortgage prices are rocketing up, pricing some people out of the market. Redfin's chief economist, Daryl Fairweather, says the country's economic woes have already cooled the housing market, and they're likely to continue dampening demand. The Fed has signaled it may increase interest rates further to combat stubbornly high inflation, which could harm consumer confidence and lower stock prices, meaning fewer prospective homebuyers can afford a down payment. I advise sellers to commit. If you decide to sell, do it quickly before demand potentially falls further. And price carefully, this is not the time to test the waters. You'll do more harm than good if you overprice and

Starting point is 00:05:46 have to do a price reduction or take the home off the market. Now, we could spend all show on this, but it's worth noting just a couple of things. This appears to be. to me to be largely driven by demand destruction and people holding off because of high interest rates rather than the supply all of a sudden being better after 10 or 12 years of a structural supply shortage. The good news about that if we keep building is that maybe we come out the other side with demand and supply leveled off a little bit more than it's been, but in the short term, if people just aren't willing to commit to these higher mortgage rates, it could be pretty tough. In times like these, security of your assets should be your number one priority.

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Starting point is 00:07:46 FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCs, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. Let's move now to a different aspect of real estate, which is small business rent. According to surveys from small business data firm alignable, 35% of U.S. small businesses could not pay their rent in full and on time in June. That's up from 26% in January. More than three quarters of business owners in transportation say gas prices have hurt their companies in, quote,

Starting point is 00:08:26 very significant ways. Two-thirds of these transportation businesses said that gas and supplies were up by more than 25 percent, and more than a third said they couldn't pass on costs in order to break even. The National Federation of Independent Business has released their June data which measures how small business owners view economic conditions over the next six months. Their business optimism index is at its lowest point in nine years. Their business activity outlook index is at its lowest point in the 48-year history of the survey. Hiring intentions have recorded one of the largest monthly drops on record. Only 19% of small businesses expected to increase employment, which is down from 26% in May's survey and a collapse of a record high of 32% in August of last

Starting point is 00:09:10 year. This, I think, has ramifications for how we view the current labor statistics which we'll get into in a little bit. But let's move now to auto loans. This is a notoriously difficult data set, but anecdotal evidence is starting to pile up that the bubble in car financing is beginning to show signs of bursting. According to Barron's, experienced car liquidation buyers are starting to see a glut of vehicles hit the market from repossessions. Normally, repossessed vehicles have a range of financing origination dates, but liquidators are noticing now that the bulk of current repossessions were financed in 2020 and 2021. During the pandemic, underwriting standards were significantly reduced. Income statements included stimulus-driven.

Starting point is 00:09:51 income bumps as well as the availability of stimulus checks and PPP loans for down payments. Some financing data on repossessed vehicles are showing loan-to-value ratios of up to 140% compared to a more normal 80%. To put a cherry on the top of this, companies in the business of repossessing vehicles are reportedly renting additional lot space to store vehicles. Auto executives from companies like America's Carmart and Ford are also beginning to discuss the risk of increased loan delinquencies in their earnings calls. Now, importantly, people who know a heck of a lot more than me when it comes to these sort of credit issues don't really see what's happening as some dramatic crash, but instead a reversion to the 2015-2019 mean. This is one interpretation of what's going on right

Starting point is 00:10:36 now that you're seeing quite a bit of. Effectively, that we are in the midst of an unwind of pandemic-era excess, rather than some sort of crash below previous averages. The problem, of course, is that we don't know exactly where that unwind ends, and it could be just the beginning. Speaking of unwinding the realities of the pandemic, let's look now at consumer debt. Credit card balances absolutely cratered during COVID because both people were buying less and also because they had more money coming in to pay down debt. This is a good thing, right? Well, don't forget we live in a consumer economy where growth is driven by people buying things. Whether that is fundamentally a good thing is a bit outside the scope of this podcast for today, but here we are. Whatever the case on that front,

Starting point is 00:11:19 credit card debt is back on the rise and savings are down. America's savings rate is at its lowest level since 2008, and credit card debt is up 30% in two months. Is this a sign of either A, excess government money running out, or B, people using credit to keep living the life they were accustomed to, even as inflation is driving up the cost of living? Obviously, if it's the latter of those to it could be extremely problematic in the months to come. Lisa Abramowitz of Bloomberg tweets, Does it concern anyone that were boosting consumer leverage, quote, heading into a hurricane? J.P. Morgan's Jamie Diamond said debit and credit card spending was, quote, up 15% with

Starting point is 00:11:57 travel and dining spend remaining robust. Card loans were up 16% with continued strong new account originations. As well as Fargo's Darrell Cronk said, he thinks investors have been sold a bill of goods about the strength of the consumer balance sheet. he points to an unprecedented build in credit card borrowings in recent months as investors use up savings. What Lisa is referring to here is a widely spread narrative from the banks and financial institutions that any potential recession isn't going to be that bad because consumers are coming into it much stronger than they have in the past. The counterpoint is exactly what this Wells Fargo executive

Starting point is 00:12:31 said, which is the troubling signs that credit card debt is going up in a huge way. Going a little bit deeper on Jamie Diamond on an earnings call this week, He said, quote, the consumer right now is in great shape, so even if we go into a recession, they're entering that recession with less leverage and in far better shape than they did in 08 and 2009. His counterpart at Morgan Stanley, James Gorman, shared that opinion. He said that a deeper dramatic recession in the U.S. is unlikely and that Morgan Stanley is, quote, long the U.S. in most of its businesses.

Starting point is 00:12:59 The J.P. Morgan's CFO, Jeremy Barnum, said, we've looked a lot very carefully into our actual data. There's essentially no evidence of any weakness. Now, if this sounds a little out of touch with the lived experience of people and basically everything else we've been talking about, you are not alone in feeling that way. But what about jobs? Last Friday's jobs report painted a picture of a labor market that was remaining tight. 372,000 jobs were added to the economy in June and unemployment approach to 50-year low

Starting point is 00:13:28 at 3.6%. Still, not everyone buys it. Goldman Sachs chief economist Jan Hatzis said in a note last Friday, software company-level hiring expectations and slower GDP growth in the second half of the year point to slower payroll growths in coming months. Recent anecdotes of hiring freezes and more selective hiring indicate that companies expect payroll growth to slow, and the most recent business activity surveys corroborate these signals.

Starting point is 00:13:54 Obviously, for those of us living in the tech sector, we already see a significant slowdown. Microsoft announced a round of layoffs this week that would affect about 1% of their team, or roughly 1,800 people. The CEO of Google told his employees, that the firm would be slowing down hiring for the rest of the year and into next year. Crunchbase is currently reporting more than 17,000 tech sector layoffs in the first half of this year. And of course, this is the same in crypto as well, where OpenC announced that it would reduce

Starting point is 00:14:19 its team by about 20% as well. What's more, July is already looking worse than June for the labor market. New unemployment claims have risen for the second straight week and hit an eight-month high. Now, jobs are one of the weirdest aspects of this whole thing. Recessions tend not to be just two consecutive quarters of negative growth, as is their technical definition, but also see a significant labor market cooling. Because there is a disparity between slowing growth in a still tight labor market, you might start hearing phrases like technical recession thrown around as a way to make it seem better. The problem, of course, with jobs

Starting point is 00:14:49 is that it's not a normal data set right now. We're still dealing with big structural changes post-COVID from the Great Resignation to trying to backfill positions lost during COVID to ramping up reshoring efforts. Market commentator Ben Carlson said this is the first recession in history where we just keep adding jobs. Lance Roberts, the chief strategist at RIA advisors said had a great question on whether the strong labor markets will keep the U.S. out of recession. Isn't as strong as headlines suggest and will turn quickly as recession approaches. On July 11th, the Atlanta Fed's Bostick commented saying that the action of the job market right now, quote, does not feel like a recession. The specific words chosen

Starting point is 00:15:26 are pretty right on does not feel like a recession. But it does feel like something. And this is where this idea of a K-shaped recession comes from. The top is definitely being impacted. When it comes to tech and risk industries, there are a ton of layoffs all over the place already, as we're seeing. What's more, there is massive wealth destruction in equities in general, so even the people who have jobs in those sectors have seen a lot of their net worth evaporate. Meanwhile, we still have job openings towards the bottom, so it feels on some level that the contraction right now is having a very different impact on two different parts of the economy. At the same time, even if we do see strength at the bottom in the form of job openings,

Starting point is 00:16:03 People's lived experience and wages in particular are still being eaten away by inflation. We've seen 15 months in a row of negative growth in inflation-adjusted wages, even as nominal wages continue to rise. The levering up an increase of credit among regular people just to afford staples is also hugely concerning. And so thus we are back to inflation. While the Fed continues to say they're not trying to create a recession, there are other prominent economists like Larry Summers who are saying that's exactly what we need.

Starting point is 00:16:31 Darius Dale, the CEO of 42 Macro, says the Fed wants a mild recession. They won't tell you that, but the reality is they're not going to get inflation down without it. At the end of the day, when it comes to people's beliefs, 55% of Americans already think there is a recession. The data is even more profound if you divide it based on politics. Currently, 53% of Democrats think we're in a recession, 65% of independents think we're in a recession, and 78% of Republicans think we are already in a recession. and what's more, according to Bloomberg, almost four and five U.S. employees fear losing their job during a potential upcoming recession.

Starting point is 00:17:07 I think what I wanted to do with today's show is try to get into some of the numbers beyond the narrative. In a weird way, words like recession and inflation can actually be used to obfuscate what impacts these things are having on real people's lives. Whereas when you look at repossessions on auto loans or home buying deals not going through because people can't afford the mortgages based on these changes, you get a much, I think, more reflective picture of what people are actually feeling right now. Obviously, these are topics that we're going to continue to cover as they evolve in the weeks and months to come. For now, I want to say thanks again to my sponsors, next to dotio, chainalysis, FtX and Ava Labs. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other.

Starting point is 00:17:47 Peace.

The Breakdown - A K-Shaped Recession?

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