2023 has witnessed a dizzying array of consensus macroeconomic views, from no landing to soft landing to a financial banking crisis and back again. The fundamental backdrop we see for the economy is that inflation, while making some progress, continues to run well above target and the labor market remains overheated. As a result, the Federal Reserve is deliberately and forcefully trying to weaken the economy, a strategy it believes is required to beat inflation. We continue to believe the Fed will be successful in its quest for a weaker economy, ultimately leading to a recession starting by the end of the year.
While the fear of recession looms, the severity of the downturn may be more moderate than initially anticipated. Factors such as relatively solid household and business balance sheets and the out-of-sync cycle of cyclical sectors like housing and the gradual resolution of supply-side issues in the auto sector may help mitigate the usual recessionary dynamics and contribute to controlling inflation.
As we navigate the third quarter of 2023, the macroeconomic outlook remains uncertain. While the prospect of a moderate recession looms, it may be a necessary step to control inflation and rebalance the labor market. Businesses are advised to be cautious of excessive spending initiatives during this period. Tightening bank lending standards and potential funding gaps could complicate business operations. Key takeaways to prepare for the coming downturn:
Assess your cash needs over the next several quarters.
Focus on the products and services that drive the most profit.
Gaining market share will pay dividends through 2024 and even more so in the recovery that follows.
Retailers should be lean on inventories going into the Christmas season.
Here is a summary of the key metrics we follow:
Retail Sales – which make up over 70% of US GDP – US Total Retail Sales have risen to record levels, albeit at a slowing pace. However, inflation-adjusted Retail Sales have plateaued for over a year as consumers feel the pinch of rising prices. Additionally, Covid-induced saving has already been spent and consumers are relying more heavily on debt to fund purchases. Credit card balances and delinquencies are rising but not yet a serious concern. On the flip side, Having said that, consumers are benefitting from a relatively tight labor market resulting in rising wages and near full employment for those looking for jobs. Individual markets will react differently to the recession, and we expect a mild decline for this metric.
Construction – US Single unit housing starts, which leads the macroeconomy by three to four months, have been and currently are declining. Low vacancy rates, along with record-high employment and income levels, suggest pent-up demand for housing. Assuming no major changes in the Fed’s inflation approach and no new banking contagion, we continue to believe the housing market is anticipated to start recovery in the second half of 2023. Despite the ongoing recession, home prices have remained resilient. As of April, US New Home Median Sales Price came in at 8.2% below the year-ago levels in April 2022.
Manufacturing – Manufacturing, as with the other major sectors, is trending down. US Industrial Production continued to tick down in June, and we anticipate it will continue to do so through the end of the year and well into 2024. Where the housing sector is one of the first sectors to recover from a recession, manufacturing is typically one of the last.
Specific Items to Consider at the Macro Level are the same as last quarter:
Retail Sales:
New: Consumers are relying more heavily on debt to fund purchases; credit card balances and delinquencies are rising but not yet a serious concern.
Total household credit card debt rose 17.2% from the first quarter of 2022. However, credit card delinquencies only rose 2.5% in the first quarter, which is well within the normal range for the prior decade.
Relative to 2022, consumers and customers will be less accepting of price increases in 2023 as the economy contracts. Sales and marketing tactics will need to be adjusted accordingly.
Focus on honing your competitive advantages and communicating them to clients/consumers to maximize your margins.
Construction:
Low vacancy levels suggest an underlying shortage of housing. In the near-term, this will limit any further decline in housing starts. As affordability constraints are alleviated towards the end of 202, plan on recovery in construction into 2024.
Stay on top of changing demographic trends, as they will drive much of the activity in this market.
With construction expected to rise in 2024, ensure your quality control keeps pace with rising volume.
Manufacturing:
Domestic manufacturing will benefit from nearshoring and onshoring in the coming years. Look beyond your plans for the near-term downturn and check to see if your business is prepared for recovery and rise in 2025.
Be aware orders are more likely to be canceled on the back of this business cycle in 2023 so do not overemphasize your backlog.
The labor market remains tight. Think carefully before cutting your workforce as it could do more harm than good when economic growth returns in 2025.
Consumers may grow more cautious as the downturn progresses. What can you do to convince them that your products are still worth the cost?