Caution in 2016!
Nate Brzozowski Feb. 24, 2016, 9:15 a.m.
In the 30-year period before the founding of the Federal Reserve in 1913, a complete economic cycle took just 40 months on average and arrived almost like clockwork. There were nine recessions during this period; they were as routine as they were violent, often punctuated by devastating bank runs and relatively prolonged periods of contraction.
In the modern era, recessions have been less regular in their arrival, and expansion periods have been lasting longer. Since 1982, we’ve only seen three recessions—one per decade.
Forecasting where the U.S. economy will go in 2016 and beyond is rife with uncertainty, but we do know that the three most recent cycles have come after expansion periods of 92, 120 and 73 months, respectively.
Since the great recession technically concluded in June 2009, 78 months have elapsed. While we may or may not see an imminent downturn, I think logic would dictate that we’re likely closer to the end of an expansionary period than the beginning. It would seem prudent that executives and investors alike should take a critical review of some legitimate market concerns in 2016:
The Baby Boomers are no longer a source of economic growth. While they may have supported the booms of the 1980s and 1990s, the days of their positive economic impacts are over. This may not be news to many, but the U.S. is just now experiencing the massive strain longer-living, longer-working Boomers will put on pensions, social security and the health care system in coming years. Additionally, Boomers aren’t retiring, which ultimately leads to stagnant wage growth, inefficient labor pool participation and slowing innovation.
Leverage is the single biggest “bubble builder” in the economy, and after six years at near-zero interest rates, it abounds. While many corporations are still flush with cash after steady deleveraging in the past few years, investors are not nearly as well positioned. This is evident in commercial and residential real estate where prices in many markets are starting to approach and even exceed levels seen in 2006/2007. Some markets like San Francisco, New York and Miami legitimately warrant discussion of buyers “return chasing” and pushing the markets into overheating territory. The exposure in New York is the high volume of mortgages and re-financings being generated on real estate at historic high prices and valuations. Any unforeseen dramatic hit to real estate pricing could once again lead to widespread negative equity positions or defaults.
More leverage. We’ve continued to generate new commercial mortgage-backed securities and mortgage-backed securities on recently traded assets, which are (as mentioned above) now at peak pricing. While not being generated as recklessly as MBS private label products were in 2007, we’ve still accumulated quite a bit of new CMBS/MBS product since 2009.
Rising interest rates coupled with low wage growth and low inflation. The Fed primarily relies on two levers it can pull to boost a faltering economy: cutting the federal funds rate or tinkering with the size of the money supply. The Fed pulled both of these levers to fight off the collapse in 2008. Boosting the federal funds rate is generally the fastest way for the Fed to reset. However, no one is sure if the current slow and unsteady growth will accommodate several rate hikes in the next year.
There is still little clarity on what’s going to happen in Europe. From Brexit (Britain toying with departing the European Union) to Grexit (Greece toying with abandoning the euro), there is still a mountain of uncertainty and legacy debt without clear resolution. The myriad political and economic drivers of dozens of countries make forecasting the Eurozone nearly impossible. A big failure in Europe could send a shockwave through the world markets overnight.
The emerging market heroes—Brazil, Russia, India, China—aren’t looking too rosy. In December, the second of the “big three” credit-rating agencies downgraded Brazil’s debt to junk status. Russia stands crippled by devastating international sanctions. China’s stock market started 2016 in free fall. Even George Soros is drawing comparisons of recent Chinese activity to the market crash in 2008. India, the sole bright spot of the BRICs club, recently revised its projected growth rate through next month downward by a full percentage point. Where will companies look for new growth markets upon stagnating demand in the West? How does this affect U.S. firms who manufacture abroad?
A strong dollar is having a big impact on U.S. imports/exports. With China implementing slash-and-burn currency devaluation and stock market interference, the dollar could become even stronger, having serious implications for U.S. manufacturing firms and any international firm now facing significant exposure on repatriating earnings generated abroad.
The glut in global oil supplies persists. With oil prices dropping to decade lows in the opening week of the year, the net impact has yet to be determined for the broader economy. Cheap oil is a boon for many consumers who have responded by buying light trucks and SUVs, But it has hit the energy sector hard, and job cuts at big energy producers will lead to a rise in home foreclosures in energy-heavy states.
Political uncertainty. A presidential election year is always shrouded in uncertainty regarding long-term policy implications. We’ve had over five years of steady job growth and economic stability, but if the markets sense we could be facing a new president with an unclear or aggressive agenda one way or the other, the reaction will be emotional and potentially dramatic.
All of these factors create a significant economic headwind in 2016 and put a strain on the global and U.S. growth projections in the future. No one knows when. All we can do is look ahead with contingencies in place.
Nate Brzozowski is a managing director of consulting services for Savills Studley.