We’re Facing a Year of Unknowns After a Couple of Years of Predictability
I suppose I have offered the same definition of an economist about a thousand times by now. “Somebody who explains tomorrow why the predictions they made yesterday didn’t come true today”. It is just that this is so very accurate. The problem is that the data shifts nearly constantly. At its heart, economics is a social science (despite our attempts to use numbers as if we were a “real” science). We study human behavior and there is no creature on earth less predictable and volatile than a human being. You remember your beloved Econ 101 class where the professor valiantly tried to assert that people “maximize expected utility.” The reality is that people rarely do this – they react to everything they shouldn’t pay attention to and ignore what they really should be paying attention to. What does this mean when trying to puzzle out what to expect for this year’s economy?
Basically, there are two schools of thought competing with one another on the subject of recession. There are the true dismal scientists that are predicting a recession in 2023 and a fairly deep one. They point to a variety of factors ranging from a slowdown in industrial production to slumping retail and the retreat seen in measures such as the Purchasing Managers’ Index. They mostly assert that the central banks are still committed to dealing with persistent inflation and that will propel them towards even higher interest rates. They cite the comments by Jerome Powell as he indicated that inflation as measured by the PCE (Personal Consumption Expenditures) is still over twice as high as the Fed prefers. They want that rate at 2.0% or slightly below and right now it stands at 4.6%.
The other school asserts that 2023 will see nothing more dramatic than a minor downturn that starts to evaporate by the 2nd or 3rd quarter. They look at the fact that inflation has started to erode (probably peaked at the end of Q4 2022). They believe the Fed will slow down when it comes down to rate hikes and they point to the still solid jobless numbers. They look at the fall of commodity prices and the surge in industries such as automotive and aerospace.
If one looks at the data that comes from the Armada Strategic Intelligence System you will observe that we are somewhere in the middle. There was a substantial peak in 2022 – a holdover from the rapid growth that was seen in 2021. That started to ebb last year and is expected to keep dropping for a while this year before tracking back up to what it was in the last decade. The long- and short-term projections are very close to the ten- and twenty-year trend lines. I continue to be impressed by the performance of the ASIS (if I do say so myself) accuracy rates of close to 96% month after month. In the more detailed breakdowns, we see some significant variations – booms in automotive and aerospace but declines in machinery. Less volatility in fabricated metal and more volatility as far as primary metal is concerned.
What is the conclusion one can draw from all this? The first is that there is a substantial degree of uncertainty to contend with and that forces companies to develop a wide range of contingency plans. The outlook for the coming year depends on factors such as Fed willingness to halt or even reverse rate hikes. There is a fear that political gamesmanship will lead to a default over the debt ceiling and that could shove the economy into reverse. Global activity will play a huge role as well. Does China finally resume its production activity or has the world moved on enough to blunt that impact? Commodities have been down but there are still major disruptive threats to oil supply as well as industrial metals. Leftist regimes in Latin America have already impacted copper, aluminum and other metals. Europe asserts that it is no longer staring a recession in the face – at least not a severe one. Does that mean more market for US goods or more competition from European producers? Probably both.
The bottom line is that companies are facing a year of unknowns after a couple of years of predictability. We all knew 2020 and much of 2021 would be miserable and we knew part of 2021 and 2022 would feature growth - we don't quite know what to do with 2023 yet.
What does all this mean for the real estate market? As with many other aspects of the economy there are some big differences according to sector and region. Commercial construction has been in a pattern for the last couple of years but these conditions are shifting. The predicted death of the office building now seems premature as companies grow tired of the virtual system. Employees may like working from home but their supervisors are not big fans and the limitations are more apparent every day. The projects are smaller and located in more distant suburbs but there is a comeback. The surge in warehouse and distribution centers has slowed as consumers are starting to return to the brick-and-mortar experience. The reduction in expansion plans asserted by Amazon just a few months ago is a case in point.
Housing has been profoundly split between the multi-family and single-family categories. Permits for multi-family are up by more than 22% and as high as they have been since the 1980s. Single family permits are down by 11%. There is still a shortage of some 5 million homes and that has been driving up house prices as well as rents. At some point the price of homes will start to fall as demand flags but it has not happened yet. Beyond that there is the regional impact – hot markets that are still blazing. As people have the opportunity to work remotely, they choose their city based on where they want to live as opposed to where they were given employment. Finally, there is the demographic driver to consider. A recent national poll found that over 27% of Gen-Z males were planning to remain living at home until their 30s. That limits the demand for both multi-family and single-family expansion. Interesting enough – only 12% of Gen-Z females wanted to remain in their parent’s home.
Chris Kuehl, PhD., is an economist and Managing Director of Armada Corporate Intelligence. Visit www.armada-intel.com for more information.