The Problems are the Path: Recession, Unemployment, Asset Depreciation...Pick your Poison

My wife refuses to give up her Hair Dresser in Los Altos California.  So every month there is a 3 hour drive to Los Altos, listening to a Books on Tape Disc that make our drive pleasant. I then can drop her off see my doctors, or have lunch with a friend, or drop into a shop and spend about 3 hours relaxing.  This last trip was something of an eye opener. 

I drove past a former client's recently property on El Camino Real in Menlo Park. It was a bad move for him to build a mixed use multi-family unit with 4 commercial spaces.  Built at the same time that car lots were torn down all along El Camino next to the Rail Line with the same concept of multi-family commercial spaces.  He had some great ideas at the time of his venture.  He planned on renting fully furnished units to the hoard of business visitors and out of state employees then coming to the Face Book, Google and related technology firms.  Thereby capitalizing on the need for small start up places.  TIMING WAS BAD! 

A few apartments were rented out long term, no commercial spaces were rented and then finally all furniture was removed, prices cut and units were rented.  The Commercial Spaces are still open.  

As I drove by the signs of an economic pending collapse was evident to me.  Bed spreads covered the windows!  That reminded me of my college days when we students couldn't afford drapes and tacked up bedsheets to keep our apartments private.  

When my wife finished her appointment she noted that there were still 3 chairs open in the Salon.  That the owner had tried to fill the open chairs with no success and was financially struggling.  There were 80 other chairs open in Los Altos her hair dresser informed my wife.  Now for Los Altos the home of a strong housing market and Short DOM for lisitngs and over bids to have wives cutting back on their hair dresser is a bit of a warning shot across the bow!

We stopped at the Los Altos Grill for lunch.  This spot had usually been a busy restaurant.  Where waiting in line or "do you have a reservation was the "ordre du jour".  Easy walk in and get a nice booth.  Waiters and waitresses stood in the rear near the kitchen waiting for orders chatting with one another.  The customer's were spattered around the restaurant with more open spaces than full spaces.

While the Pandemic has been given as a reason for the change in hair habits of women and eating habits of most residents, this is some 2 years after the end.  So there must be more to the story of empty restaurants and open salon chairs in Los Altos.  

Could this be a precursor of a recession?  Damir Tokic a writer for Seeking Alpha, a financial website, recent contribution offer just that: S&P 500 Recession to Hit Just Before the Election.

• ISM Services for April shows contraction in the U.S. service sector, a key driver of the economy, while the U.S. economy added fewer jobs than expected.
• Based on this data, the U.S. economy is likely slipping into a recession in Q3 2024.
• Thus, S&P 500 is facing a recessionary bear market, which could be brutal as the mega-cap tech bubble burst.

The labor market report for April showed that the U.S. economy added only 175K new jobs, which was well below the expectations of 245K. This data, on the surface, points to a slowing U.S. economy.

But more importantly, the ISM Services for April came at 49.4, which indicates that the U.S. service sector is contracting. This was completely unexpected by the market, as the consensus expectation was 52.

This is important because the service sector remained resilient due to the strong consumption, which accounts for 70% of the U.S. economy.

Thus, it appears that the U.S. economy is slipping into a recession.

The recent forecast by ING, which is dated April 25th, predicts that the U.S. Q3 GDP growth rate would be at 0% in Q3 and 0.6% in Q4. This forecast was published before the recent unexpected weak data, and, thus, it's likely to be revised to a negative number.

Based on a normal business cycle, once high inflation becomes unsustainable, the Fed is forced to increase the short-term interest rates above the long-term interest rates to invert the yield curve.

An inverted yield curve creates a restrictive macro environment where credit availability is reduced, particularly to more financially vulnerable firms, which eventually results in less investment and higher unemployment. In addition, higher credit costs reduce credit consumption, which also reduces investment and causes a higher unemployment rate.

Thus, an inverted yield curve generally precedes a recession. However, the effect of the inverted yield curve on the economy has "long and variable lags". This means that it takes time for the yield curve to actually affect the real economy. Generally, a recession occurs 12–18 months after the yield curve initially inverts.

However, the findings show that a deeper and longer inversion of the yield curve produces a deeper and longer recession. The chart below shows the difference between the 10Y Treasury yield (US10Y) and the 3-month Treasury Bill yield (US3M) - that's the yield curve. During the current cycle, we have a record deep inversion, and a record long inversion. Based on this observation, an inevitable recession should be deeper and longer than usual.

So, that's the macro reason behind the expectations of an imminent recession.

The April labor report also came much weaker than expected. The market consensus was for 245K new jobs created, while the actual number came at 175K new jobs created, with an increase in the unemployment rate from 3.8% to 3.9%.

Obviously, the key implication for the stock market is that a recession usually produces a recessionary bear market, which could be a very deep 50%+ drawdown like in 2001 and 2008, or a minor 20% correction like in 1991.

With the correction in the stock market and especially in Technology that drives California there will be weakness in housing price from the resultant loss of jobs and net worth.  Then too, there will be rents declining.  Those units along the Rail Road Track are still looking for renters!

The latest from the FED is that Quantitative Tightening will diminish a bit to about $35 billion a month.  That still means money is being taken out of money supply and rates will still remain high.. High interest rates are like Holy Water to Vampires when one considers Technology stocks.  Even Warren Buffet took some profits in Apple, won't other investors do the same for recent run ups in technology and AI issues?

Expect a Summer Sell Off in the Technology Market and the S&P in general.  Real Estate will see that in reality the Buyers are the Kings.  It may look like a Sellers Market when the inventory is taken into consideration.  When one looks at price cuts it is really the Buyers who are calling the market.. Then we must consider the July ruling in the Real Estate Industry Settlement and how buyers and sellers will handle the market place.  It may be chaotic at first before order comes into play.

Add to that another Kent State, a missile into Moscow, an incident at the 38th Parallel, Tehran miscalculation.  Things could get messy REAL FAST!  Not to forget Politics of Donald and Joe and their supporters and another contentious election and result.

It all sounds like Doom and Gloom, but in reality more a case for an interest rate cut after the election and a number of others thereafter.  

Plan your Summer Accordingly!

As before, call or write for any question you may have and think of me of your "in the know real estate professional".