Economic outlooks posted to online news sites dominate our feeds with implications of prosperity or doom for the general American. Given the sensationalized nature of American media and their search for clicks, formulating an opinion on where the economy is headed is extremely difficult. Is it the next financial crisis? Will there be a soft landing? Or will the NASDAQ keep breaking records year after year? It’s hard to tell as most macro indicators have a poor record predicting the future accurately. Something as complex as the economy makes finding cause and effect very challenging. I think that we are not headed for a catastrophe as some may believe but rather a short term recession. Driving this recession is the overuse of speculative assets and the inflated cost of living, especially housing.
The housing issue
The housing market is a key indicator to the future of the economy because it impacts the emotion of the “common man”. The emotional value of the consumer is so important because it impacts behavioral trends such as spending. Housing costs are typically one of the biggest expenses on a personal budget therefore when these prices rise, they are more likely to trigger a behavioral change. Evidently, homebuilders are betting on tightening budgets and predicting an increase the amount of families that decide to rent. Last year 39% more single family rental homes were built than in 2022. This means homebuilders and investors are looking to profit off the growing need for rental properties. Real estate is going to have a lag on liquid return due to the time it takes to build properties and then fill them. Therefore, these companies are willing to take on debt and risk.
How does this impact the macroeconomic situation?
I think house prices trigger the consumer behavior switch in which we will see less spend. As more people struggle to pay their debt coupled with higher inflation, we will see the economy shrink due to lower consumer demand. Companies will have to pivot to meet the demands of a pickier consumer. If we take the food industry as an example there is an uptick in consumers electing for snack foods over meals. CEO of Mondelez, one of the biggest food manufacturers, has acknowledge snacking has grown significantly post pandemic and the company will place an emphasis on fulfilling the consumers demands. Snacks being cheaper on average means a volume uptick will have to take place to continue high margins. To me this seems difficult to achieve if the consumers’ pockets continue to shrink. Furthermore, as consumers realize their struggles, the election year will play a pivotal part in the economic resilience. It seems there is greater divide than ever between political parties and their common ground, and I think this social pressure will add to the volatility of the markets.
A time of speculation
My second area of concern is speculative market conditions. In the last two weeks, for example, we saw an uptick in volatility and thus the creation and deletion of wealth in mere hours. The Dow hit 40,000 on the back of tech stocks and increasing belief of rate cuts and meme stocks returned. It’s hard to beat good press in the sense that it seems like everyone is making money. I see this as a warning. The teachings of Graham and Buffet are quiet and quite boring, but they aren’t wrong – it’s hard to beat the market and almost no one does so long-term. So, while some are inflating their pockets with successful speculation, it’s short term. If I had to guess these efforts are by people that are well enough off to put 100k into GameStop and not be homeless.
I see this trend beginning to slow as overvalued assets are effected by interest rates remaining high. Things like long term commercial real estate bonds and other long-term debt with lower cash flow is worrisome and we have not seen too many severe negative consequence thus far. One that opened my eyes being a $308 million AAA mortgage-backed note that took losses unseen since 2008, as reported by Yahoo finance. This note was a mortgage that Blackstone took out in 2014 to pay for an office tower in NYC. Over the last few years rent has not been giving a significant enough cash flow and Blackstone defaulted on the loan. And last month Blackstone sold the building and the original debt lost 26% in value. A loan rated AAA has a very low rate of default. I see this as a real issue that hasn’t yet manifested because these commercial loans are long term, and many were locked in with low interest rates. When refinancing occurs they will incur losses or refinance with non-bank loans. Which simply tells me more speculative efforts to make deals work with these non-bank institutions may occur because of their lack of regulation and quick decision making ability. I honestly do not know enough about the so called shadow banking system to truly understand it but coupled with $929 billion on commercial RE mortgages that are set to mature this year, I cannot imagine it goes swimmingly.
Why the dominoes stop?
Overall, I think the economy is in good standing due to the companies at the helm of economic growth. With the combination of marketing and technological advances consumers are able to adapt to market conditions fairly quickly. Successful companies that are going to drive the economy forward are using their free cash flow to reinvest to what they believe the future holds. Right now, the many businesses are coming off an excellent COVID rebound and are even more prepared for the next downturn. Historically, we’ve seen companies such as Apple prepare for the future. In the years preceding 08-09 they invested in the next generation of iPhone tech releasing the 3G iPhone in 08. If we go further back to the dotcom bubble, Netflix is known for reimaging their future and prepared for the future of streaming. I believe these two companies provide a microcosm of what we see today but at an even higher percentage. I think there are a lot of companies successfully investing in technology for the deployment of AI, renewable energy, or electric vehicles that will drive the economy of the next 20 years. In the modern economy I view it as an all hands on deck situation with the intricacies of global business. For example, if NVIDIA continues to increase their value, then their raw materials providers, distributors, users, and shareholders will benefit as well. Leaving us primed for the successful AI economy of the future.
Quick Links and References
Cummins, C. (2024). Shadow bank lending on the rise as big four pull back. The Sydney Morning Herald. https://www.smh.com.au/business/companies/shadow-bank-lending-on-the-rise-as-big-four-pull-back-20240229-p5f8uh.html
Hadzi-Vaskov, M., Pienknagura, S., & Ricci, L. A. (2021). The Macroeconomic Impact of Social Unrest. IMF Working Papers https://www.imf.org/en/Publications/WP/Issues/2021/05/07/The-Macroeconomic-Impact-of-Social-Unrest-50338
Arroyo, C., & Wong, N. (2024, May 23). Losses pile up in top-rated bonds backed by commercial real estate debt. Bloomberg. https://finance.yahoo.com/news/losses-pile-top-rated-bonds-110000825.html
Silver, N. (2020). The Signal and the Noise: Why So Many Predictions Fail – but Some Don’t. Penguin Group.
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