We discussed the inevitable slowdown in North American housing weeks ago and, since then, the data has not only supported this outcome, but shown a faster correction than expected. Case in point, Toronto home sales fell 41% in June from a year earlier (fourth consecutive monthly decline) and prices fell 3% as listings surged. It’s possible that something similar could begin to emerge in the labour market, which might relieve the extreme supply-demand imbalance we have found ourselves in.

 

Such a pronouncement may sound premature and outright wrong, considering that Canada’s unemployment rate sits at a record low of 4.9% and the annual growth in hourly wages for Canadian permanent workers has risen to 5.6% from zero this time last year. Likewise, the US unemployment rate, at 3.6%, is just a tenth of a percentage point above the pre-pandemic low of 3.5% - which was also the lowest it had reached since 1969. Average hourly wages in the US were up 5.1% in June, as reported in this morning’s payrolls release.

 

 

But, in both cases, wage growth still hasn’t reached levels seen prior to the pandemic and there are signs that things are cooling off. The June jobs report for Canada showed a net decline in employment of 43,200 – reversing the previous month’s gain. US non-farm payrolls for June rose 372,000, which was about 100,000 higher than what economists had predicted; however, there was a net downward revision to the two prior months of 74,000. Weekly hours also declined by a tenth and the labour force participation rate fell to 62.2%.

 

Even before this morning’s labour reports, evidence was slowly creeping in that the imbalance was abating. Initial jobless claims for the US rose to 235,000 in the last week of June – the highest reading since January and compares to a low of 166,000 in mid-March. The increase over the past three months is reminiscent of the bounce we saw in 2019 after initial claims had hit 173,000 (then the lowest since November 1968). A rising rate environment through 2018 worked with a lagged effect on labour demand, though the unemployment rate continued to edge lower despite rising jobless claims. So far, the same looks to be holding true, but we are in the early stages of this economic slowdown.

 

 

After being in negative territory from February 2021 to this past March, the annual change in the Challenger US Job Cut Announcements has turned positive. The latest read for June had it at +59% - a far cry from the massive gains during the pandemic period, but on par with what we saw during the softer growth phase in 2018-19. Since we have become so used to headlines of record job postings, a shift in the trend of staffing reductions is worth watching. That said, while growth in layoffs has picked up, the actual level of cuts is still below the average between the financial crisis and the start of the pandemic.

 

Because labour force statistics are lagged by nature, akin to driving a car by looking in the rearview mirror, they are not going to be overly instructive as to how things are going to develop today. However, when the trend shifts it can be a very useful indicator as to how the general economy and markets will move in the months and quarters ahead. Like the housing sector, it is also possible that this shift will take place faster than what economists would normally predict. A few weeks ago, I commented as to how Bay Street was historically reluctant to use the “R” word, yet today we are seeing institutions trying to beat each other to the recession forecast. I would posit that the dramatic shift in housing and potential turnaround in employment has a lot to do with that.

 

 

Historically, when unemployment claims pivot and unemployment rates begin to turn higher, the resulting trends become entrenched. The above chart shows US initial jobless claims against the US unemployment rate. I have mapped it to just prior to the pandemic given how 2020 distorted both series. As you can see, the bottom for claims typically occurs a few months before the bottom of the unemployment cycle.

 

The major turns take place when the economy falls into recession. Assuming the upward trend in claims continues, this would suggest that a recession could take place anywhere from a few months from now to sometime in 2023. Indeed, a growing number of economists are placing better odds on an early-2023 recession, although most are indicating a mild and short recession at most. Just how mild and short a downturn might be, is going to depend on the consumer which, in turn, will dictate the reaction of businesses in terms of staffing. If investors haven’t figured it out yet, response times are dramatically shorter now than anytime in modern history.

 

 

For example, look at the how American consumers view their financial future. The University of Michigan consumer sentiment survey produces a ton of useful data each month. One indicator from the survey is the expected change in financial situation in a year – specifically, if the situation will be worse. The data for this series goes back to the late 1970s and you can see that this particular index has broken above the 30 level twice this year and is higher than back in 1979 and 1980. The index representing those that believe their situation will be better a year from now has fallen to the lowest levels since 2014.

 

Now, consumer confidence measures do not always predict changes in actual consumer spending patterns. They are reflections of mood and mood is affected in a much more high-frequency manner today. If I told people that inflation had come down more than what officials thought, and that interest rates would not have to go up as much, you can imagine that confidence levels would turn around.

 

I would argue that we won’t get a real handle on this until next month, when July CPI figures are released for both Canada and the US. The reason I say that is because July is the first month in a long time that we have witnessed price declines across several sectors, from commodities, to gasoline to homes. Bottom line, the recent situation where wages can be bid up at will and people don’t want to move back into the labour force could change as a result of worsening financial situations at home and less help wanted signs hanging in the window. More individuals will likely want to make themselves available for work and businesses may have more competition for a job, versus competing for the one person for the job.

 

The bigger issue is how we structure the portfolio to deal with a potential consumer-led recession, but also for just a mild and short slowdown? For the US equity market, let’s look at three periods of rising unemployment and economic contraction. For this exercise, I examined the periods from the trough in the unemployment rate to the next peak. In 1989-1991, the economy experienced a pullback, but the S&P500 actually advanced 27% over the period, led by health care and consumer staples. From spring 2000 to June 2002, the S&P500 lost 32%; however, consumer staples advanced by 30%. The 2007-09 experience was completely different as no segment of the S&P gained over that entire period and the S&P lost more than 28%. Yet, consumer staples outperformed with a loss of around 6%.

 

This doesn’t suggest we shift the entire portfolio into consumer staples, but it is an argument for building exposure – no different than our decisions to begin increasing exposure to residential REITs, on the assumption that rental demand will pick up as home prices decline. Ally and I still believe that a recession, if it materializes, will be moderate. There is a huge underlying assumption that the global political situation doesn’t get any worse than it currently is; because fiscal leadership in the next downturn will be even more important now that monetary policymakers are still figuring out how to tighten on the doorstep of a recession.

 

On behalf of the Pyle Group, have a wonderful weekend.   

Andrew

 

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