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Recession is Coming

Written by Briton Ryle
Posted July 3, 2017 at 6:38PM

2007, 2001, 1990, 1981, 1980, 1973, 1969, 1960, 1957, 1953, 1949, and 1945. 

What do these numbers have in common? They are the years in which each of the last 12 recessions began for the U.S. economy. In just one case since the end of World War II did the economy make it more than 10 years without going into decline for a couple quarters.

I like to keep this little stat in mind as we head into the second half of 2017.

The last recession, kicked off by the quickly escalating subprime mortgage fiasco, officially started in December of 2007. Now, just because we are nearly 10 years removed from that last recession doesn't mean economic activity will automatically kick into reverse and start another vicious cycle. There's no magic formula that says economic activity has to stall every so often. 

But there are reasons that economies tend to follow the boom/bust pattern. And I'm seeing signs that the current lame excuse for a boom may be getting a bit long in the tooth. 

When a bust comes along, it wipes some of the slate clean. People stop borrowing and spend less. They try to pay off debt and save money. Interest rates fall. Corporate earnings drop. So prices and asset values drop, too. It keeps going until people decide prices are low enough to be attractive, and they start buying again. 

Yeah, it's a simplistic example, but the point is that the early stages of an economic recovery are usually spent simply retaking ground that was lost during the recession. It's not until the later stages of the recovery that debt levels really start to expand and spending really picks up. And it's usually not long after that when interest rates rise and start choking off the rate of expansion. 

There are plenty of reasons to think we are near the end of the post-financial crisis recovery and that recession is looming.

Debt, Cars, and Housing

American household debt levels hit $12.73 trillion in the first quarter of 2017. That's just slightly higher than where debt stood as the financial crisis kicked off 10 years ago. 

In and of itself, the fact that we've hit pre-crisis debt levels is meaningless. Consider that mortgage debt ($9.6 trillion) is actually a bit below where it was in the years before the financial crisis. Auto loan debt ($1.17 trillion) has been rising since 2011, and student loan debt ($1.34 trillion) has been rising ever since they started tracking it. Credit card debt ($764 billion) actually showed lower balances, but delinquencies have been rising for 17 straight quarters. 

Absolute levels of debt aren't what get you. It's growth. And both home sales and auto sales have been declining for a few months...

On June 14th, I wrote how Morgan Stanley has already lowered auto sales for 2017 to 17.3 million units, from 18.3 million. That's a hefty revision, and it gets worse. Morgan Stanley thinks only 15 million new cars get sold in each of 2019 and 2020. Ford had already announced that it will lay off workers and cut salaries in order to achieve $3 billion in cost savings to offset the sales slowdown.

With the 1.7% year-over-year drop in May, existing home sales have now been falling for three straight months. The issue is a combination of supply and price. There aren't enough houses, especially at the low end of the market, and prices have been rising fast. Analysts are worried that we may have seen the top for home sales during this cycle. 

Unfortunately, these aren't the only signs that growth is slowing. Oil prices continue to be weak, and this could be a problem, too. When oil prices rallied earlier this year, after OPEC agreed to extend production cuts, U.S. oil companies started drilling like crazy — and banks started lending to oil companies again. This won't end well if oil prices continue to fall...

Oil companies will have no choice but to cut drilling and jobs. Cash flows will shrink, and banks will once again be overexposed to a weak sector of the economy. 

We already know retail companies are in bad shape. The U.S. still has three times the retail square footage per capita than any other country. Expect the layoffs to continue here, too.

Is it Really Getting Better?

The irony to all this is that both consumer sentiment and business sentiment is very high. Earnings are great, and stocks are at high levels. Many people are interpreting this to mean that growth is on the verge of accelerating. They will even point to the Fed's rate hikes as a sign of confidence that the economy is strengthening. 

And that may be true. With the employment market staying strong, maybe growth is about to accelerate. Maybe...

But the problem I have is that the numbers are not getting stronger — they're getting weaker. Economic data is not surprising to the upside anymore. Housing costs are up 19% over the last year. Tax burdens were up 10%. Auto insurance is up 9%, and total debt payments rose 4%.

And, of course, wages aren't rising. Households are getting squeezed. Consumer spending has been basically flat for two months, even when you take into account cheaper gas prices. 

Never forget that consumer spending accounts for two-thirds of the U.S. economy. Maybe I'm being a stick in the mud, but I simply don't see much reason to think spending is going to suddenly accelerate.

I can't pinpoint the timing, but I think it's much more likely that we see consumers pull back on spending. And that's all you need to get a recession going.

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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